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Cash Poor

Dear Dave
We seem to be very busy and send out lots of invoices, but we hardly ever seem to have cash on hand as we need it. I believe the problem is related to the high amount of unpaid accounts receivable that we seem to always be carrying. What is an appropriate amount of accounts receivable for a consulting engineering firm to have and what can we do about this problem.

Dear DD
The dollar amount of accounts receivable (A/R) outstanding is relative to the size and billing volume of each firm so there is no particular dollar figure I would be able to provide you. A more appropriate measurement of the health of your A/R can be found instead by looking to what’s called the Account Receivable Aging Report for your answer.

The A/R aging report is typically produced monthly and sorts and lists the invoices still unpaid as of the date of that particular A/R report into columns of receivables 30-60-90-120 days old and older based on the original billing date of each invoice. According to a survey of architectural and engineering firms done last year, the average (median) time it takes to collect an invoice once sent to the client is about 69 days.

As critical as A/R management is, it is the only the tip of the collection iceberg. Making cash collection matters worse at many firms is Work in Process (WIP). WIP is the value of work your firm has completed on projects at any given time that for whatever reason has not yet been invoiced to clients. Think of WIP as being a kind of immature or early A/R. Sophisticated accounting operations track and age their WIP in the same manner as they track and age A/R. Keeping WIP to an absolute minimum, by getting your firm’s efforts on an invoice and on the way to a client for payment is really the first step in improving cash flow.

The ultimate goal is to invoice WIP and collect A/R in such a way as to keep the average age of each as "young" as absolutely possible. Shortening the average age of collections starts all the way back at client selection and project negotiation, long before a project even begins. It’s my opinion that too many firms don’t do a good enough job at either qualifying their clients, or are too passive when it comes to setting and clearly discussing up front your firm’s expectations for getting paid on a regular basis. Your clients are demanding a high level of service and expectations for how you will perform; and if you perform, you in turn are entitled to expect the same of your clients, which most certainly includes getting paid as agreed.

Don’t wait until an invoice reaches 30 or 60 days unpaid beyond what you’ve agreed to. Get on the phone and inquire the day an invoice is late to begin the process of collection and stay on top of the situation until it is resolved. All firms should track the average age of A/R (and WIP if you’re up for it) from one month to the next as an important barometer of the overall health and effectiveness of your firm’s client selection process, accounting operations and project management efficiency.

The largest single category of expense in a consulting firm is payroll and related taxes and benefits, which depending on your firm’s payroll schedule, must largely be met every week or two. When it takes over two months (69 days) to collect client invoices, with the bulk of your cash consuming expenses hitting every couple of weeks, it is no wonder firms struggle with cash flow. To cope, firms must either get much better at client negotiations and collections, or build up sufficient internal capital reserves over time to deal with this awkward pattern, or be resolved to depend heavily on borrowing to bridge the gap. Relying on increasing capital and borrowing as solutions both represent an increase in your firm’s breakeven overhead cost. This increase could likely be avoided, or greatly reduced, by employing improved invoicing and collection practices.

Wahby and Associates