Getting clients to pay isn’t easy. As more invoices remain outstanding, accounts receivable creeps upward. As an attorney responsible for the firm's financial success, it's important to understand the real cost of accounts receivable. Here's a simple way to estimate those costs.
Step 1: Estimate the average amount you are owed at any given period during the year. Let’s say, you typically have $100,000 of accounts receivable.
Step 2: Take a look at how much money you took home last year for every dollar you spent on your firm. For example, if you spent $300,000 on your firm and were able to take home $100,000, then your return is 33%.*
Step 3: The cost of your accounts receivable is the average outstanding accounts receivable times the return you would expect to see on that money if it were in your firm's bank account. In our example, this is $100,000 x 33% = $33,333 per year!
Note: This calculation doesn’t include the administrative costs associated with tracking down late-paying clients.
What happens if you reduce the time it takes you to collect?
With $100,000 in accounts receivable and an annual income of $500,000, you "turn over" your accounts receivable five times per year ($500k divided by $100k). Said another way, it takes you 73 days to collect payment on average (365 days divided by 5 times per year).
What if you found a way to reduce collection time by just two weeks to 59 days? 365 days in a year divided by 59 days to collect = 6.2 times per year. This would reduce your average outstanding accounts receivable to $81,000 ($500,000 divided by 6.2).
At our 33% cost of capital, the cost of accounts receivable would be $81,000 x 33% or $26,600. This would represent almost $7,000 in annual savings ($33k-$26k).
So what can you do?
Gravity Legal provides innovative solutions that reduce payment roadblocks, making it easier for your clients to pay their bills and reducing collection times. Schedule a Demo today.
*For more a more thorough analysis, of this number, search online for how to calculate your weighted average cost of capital (WACC).