same treatment from them.
• Correct billing errors quickly and err on the side of making immaterial concessions to clients when payment liability is less than crystal clear.
• Ensure that your staff has a clear understanding as to who holds primary responsibility for invoice collection (e.g., finance or another client-facing firm employee). Measure their performance and graph it.
Review those graphs monthly and acknowledge and reward good collec-
tion results (as opposed to efforts), for example, less than 1 percent of all billings being past due.
Many unpaid invoices never should have been issued in the first place, and professional firm executives should investigate and understand fully the chain of events that resulted in an invoice being rejected for payment.
In most cases, that investigation will uncover internal operational issues within the firm that executive management needs to address outside a financial context.
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WORK IN PROGRESS.
Work in Progress (WIP), sometimes referred to as
unbilled expenses or work in process, ref lects accumulated out-of-pocket expenses made on behalf of a client that have yet to be billed /invoiced. Some firms also may include the value of staff time at standard billing rates that include profit in WIP accounts. For expenses to be booked in these accounts, the firm should have a written agreement with the client that specifically states that such costs will be reimbursed. Without such an agreement, costs incurred on behalf of a client should be expensed during the period in which they were incurred, just like any other operating expense. Once WIP balances are billed, the balance of the WIP account is reduced by the amount of the invoice, which in turn increases the A /R balance.
The objective in managing WIP is to maintain the balance at or below zero. Successful firms are able to do this by entering into prebilling arrangements based on an estimate of expenses to be incurred where the client has agreed to pay the firm based on that signed estimate and then the firm uses that money to cover expenses it incurs on the client’s behalf. In those cases, the firm would credit WIP for the amount billed and as expenses are incurred, debit the balance as it would under an arrears-based system. Until accumulated expenses exceed the amount prebilled, the balance in the account will be a net credit (negative). Individual arrangements may be negotiated based on the facts and circumstances with each client and project, but often the balance is reconciled at the end of the project and the difference is either billed to the client (if a debit) or paid back to the client (if a credit).
The logic behind these types of prebilling arrangements is that the firm is not a bank, and it should not be responsible for borrowing material amounts of money to finance client initiatives. However, insignificant sums such as nominal travel-related expenses normally are financed through the firm’s working capital.
Separate WIP accounts should be established for each client and, if the firm has undertaken more than one project for the client, separate accounts for each of the client’s projects/jobs. As the number of open jobs increases, so does the risk that amounts included therein may not eventually be collectible from the client. Because these accounts are not part of the P&L, they traditionally receive little attention from senior management. When little attention is paid to these accounts, it is very easy for unbillable amounts to be charged to them instead of to operating expenses within the period incurred. Thus, the opportunity exists for expenses to be hidden and the firm’s profits to be overstated. Executive management can take action to prevent this from occurring by:
• Reviewing an aging report for all jobs comprising WIP and investigating any unusual amount that has not been billed within 30 to 60 days of being booked. Obviously, the exact number of days and the amount of
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investigation required will vary by type of firm, but the point here is that any unusual amount should be resolved as soon as possible.
• Ensuring a signed client agreement is on file that specifically authorizes the firm to bill the client for the expenses being incurred before opening the job in the accounting system. However, it may not always be possible to do this as certain clients may need the firm to move
more quickly than their own internal approval process will allow. In those cases, a second senior firm manager should authorize the opening of all such jobs in the accounting system to ensure proper visibility of the client approval issue.
• Conducting monthly reviews of a report of all open jobs that are not yet authorized in writing by the client and follow up on those that have been opened more than a month without the client’s written approval.
• Having the CFO conduct a quarterly review of all aged WIP accounts, with appropriate follow-up on all unusual amounts.
FIXED ASSETS AND DEPRECIATION.
Fixed assets in a professional ser-
vices firm generally consist of leasehold improvements, furniture and fixtures, and information technology equipment. To qualify for capitalization treatment as a fixed asset, an item must be substantial in nature and have a useful life in excess of one year. Although there is no rule as to the specific dollar level that must be used, many firms today set a policy that the cutoff level for capitalization is $1,000 per item purchased since costs to account for items of lesser value most often outweigh the benefit of capitalization.
Any item that is short-lived (less than one year) or has a unit cost less than $1,000 should be expensed, unless it is an inseparable part of a project costing more than $1,000 in total.
The capitalization dollar limit should be applied on a per unit basis and not the total invoice amount. For example, if two component parts are purchased for $700 each within the same order, they should be expensed even though the invoice total is above the $1,000 threshold for capital treatment. Similarly, this same general rule applies to software. If a perpetual license of a software program was purchased and the cost was under the $1,000 threshold, the purchase should be expensed. However, if multiple copies are purchased as part of a major project initiative (e.g., rollout of Windows 2000), the cost should be bundled and capitalized even though the per unit cost is below the threshold. Annual licenses should be expensed in the year purchased because their useful life does not extend beyond one year. Training costs normally are expensed unless bundled within the cost of the base asset. Purchases under these thresholds should be expensed in the month the cost is incurred.
Depreciation and amortization of these costs are based on estimated useful lives. With respect to leasehold improvements, their useful lives should
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never be longer than the base period remaining on the lease, excluding any option period. Computer-related equipment normally is depreciated over a three-year period as technological advances, coupled with wear and tear, particularly on portable units, leave any longer period misleading. Once useful lives of assets are established, that schedule should be followed consistently for all similar items until such time that it is proven that materially shorter or longer periods are appropriate to ensure consistency in applying the matching principle. All of the rules that a company decides to follow for capital should be thoroughly reviewed against IRS regulations by a qualified tax expert.
ACCRUED LIABILITIES. Accrued liabilities are obligations that the firm owes at the end of an accounting period that have yet to be paid. Under GAAP, the value of those obligations must be ref lected in the financial statements of the firm even though they have not been paid. When closing the books each month, well-managed firms employ procedures to ensure that all material liabilities are properly included in the financial statements in conformance with GAAP. When firms are relatively small, owners and bookkeepers are able to track most every liability in their head and easily estimate them in the financials. But as the firm grows, processes and procedures must be utilized to formalize the tracking and expense estimation process.
For example, in a firm of 10 to 20 people, the bookkeeper can easily track the number of business trips made each month and estimate the cost of each based on the destination and duration of the trip. However, in a firm of 500
professionals, organized within multiple departments and perhaps offices, it is difficult enough to know all of the names of the staff much less track their whereabouts and travel expenses throughout the month.
In this example, one process that could be employed to track travel expenses is to compare reports from the travel agency against expense reports processed to determine the value of trips yet to be accounted for before closing the books each month. However, if the firm does not require employees to use a single travel service that can deliver such a report in a timely manner each month, alternative approval and tracking procedures must be established if travel is a material expense for the firm. As firms grow, the probability increases significantly that material liabilities will not be included in the financial statements, thereby overstating profits and balance sheet strength.