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nal entries necessary to close the books for the period

The key deliverable from this process is a comprehensive set of financial
statements and graphs that provides senior management with a solid under-
standing of its past financial performance as well as a view of its pacing to
366 The Back Office: Efficient Firm Operations

achieve current and, to a certain extent, longer term financial projections.
Many executives prefer to receive a bound package each month in which the
following statements are included:

EXECUTIVE SUMMARY. Often referred to as a “dashboard,” this one- to
two-page narrative summarizes key results and variances, pointing out the
important issues an executive should know in case he or she were not able to
study any other report in this briefing package.

PROFIT AND LOSS STATEMENT. P&L should ref lect performance for
the month and year to date and be compared against budget, the last fore-
cast (and any other quarterly forecast that the firm chooses to measure itself
against), and the prior year. A variance analysis should accompany this
statement that explains brief ly the reason for any material variance (e.g.,
±10 percent).

BALANCE SHEET. This summary-level balance sheet shows key line items
within current assets and current liabilities as well as long-term assets and li-
abilities. The executive summary should discuss brief ly the changes in A /R
and WIP as well as current liabilities.

CASH FLOW STATEMENT. The cash f low statement reconciles the change
in cash balance and details the major sources and uses of cash. Executives
should pay particular attention to the first major subtotal that quantifies cash
f lows from operations because, over time, this is a key indicator of the firm™s

MONTHLY FORECAST. This forecast juxtaposes actual results for each
month in the current year with projections for each of the remaining
months of the year that, on a consolidated basis, will result in a forecast of
the current fiscal year. This is arguably the most important report in the ex-
ecutive briefing package as it provides the best estimate as to the firm™s per-
formance for the year and it is from that forecast that key strategic decisions
must be made.

ACCOUNTS RECEIVABLE AGING. This summary-level report of the aging
of A /R by client shows total balances by each 30-day aging period. Firm
management should be particularly concerned with any balance outstanding
more than 30 days and should take personal action on balances more than 60
days past due.

METRICS. The firm™s performance relative to others in its industry should
be monitored and studied by senior management. To do that, certain ratios or
metrics can be used as key barometers of the firm™s financial health. Chap-
ter 2 details metrics appropriate for professional services.
Finance, Accounting, and Human Resources

PROJECT/CLIENT COST ACCOUNTING. To hold individual project or
client managers accountable for the resources they use, cost accounting re-
ports should be reviewed and used to form the foundation for subsequent ex-
ecutive level project or client reviews.

TIMESHEET SUMMARIES. Executive management should review statistics
on the performance of its most valuable and limited resource, its staff, and
the number of hours available to charge to clients. Two reports are key to ef-
fective utilization of the firm™s staff:

1. Staff utilization: These reports summarize the number and percentage
of hours charged directly to clients and to nonchargeable administra-
tive efforts. Staff utilization targets should be established during the
annual planning process and measured each month (e.g., staff should
have at least 90 percent of their time charged to clients; managers, 75
percent; senior managers, 65 percent; and partners, 50 percent).
2. Missing timesheets: Cost accounting in a professional services firm is
meaningless unless all timesheets have been completed and incorpo-
rated into the cost accounting reports. If not well monitored by senior
management, staff can fall behind in completing their timesheets as
they focus their efforts on urgent client demands. If staff know that
management receives a written report on who is late in completing
their timesheets and follows up with firm support for their comple-
tion, the delinquency rate will be much lower than if such statistics
were not publicized.

vides executive management with a summary report of all amounts that the
firm had to write off in the process of servicing each client, with a brief de-
scription of major items, to provide executive visibility with respect to mis-
takes and waste.

SUMMARY OF CAPITAL PROJECTS. This report summarizes the status of
capital spending by listing each of the firm™s approved capital projects, the
amount approved, the amount spent or committed thus far, an estimate of
additional funds required to complete the project, the new projected total
(actual plus the estimate to complete), and the resulting variance from the
original plan.

DAILY CASH RECEIPTS REPORT. Although not necessarily part of the
monthly reporting package, it may be helpful to circulate a summary of cash
receipts by client in order to keep executive management informed of each
client™s payment status, particularly if the executive will be meeting with the
client. This procedure helps to avoid situations where a senior member of the
firm might be in a meeting with a client and inquires about the status of its
368 The Back Office: Efficient Firm Operations

unpaid bills. If the bills have already been paid, the executive can avoid the
embarrassment of having to apologize for referring to outdated information.

GRAPHING RESULTS. Many executives in large and small firms alike pre-
fer to review graphical renditions of their financial data to facilitate their
review and understand results quickly in context of historical and relative
trends. Key items that work well in graphical form include:

• Revenue and expense graphs: These combined line and bar charts show
the firm™s actual results as a bar and prior year, budget, and forecast
data as lines for all key accounts including revenue, salaries, and other
material overhead accounts.
• Accounts receivable aging graphs: To track the effectiveness of the A /R
collection process, it is useful to graph the aggregate balance of amounts
in each of the past due categories (e.g., all amounts over 60 days past due
graphed over a two-year period).
• Staff utilization: Total hours charged, average rates, and utilization per-
centages over time can also be graphed.

There is a fine line between finance and accounting with many interdepen-
dencies and tasks being performed by the same personnel, particularly in
smaller firms. A well-managed firm is one that has sufficient capital
resources to weather storms, negotiate mutually beneficial deals with its
clients, plan ahead, both in the short and long term, and invest in its future.
In this section, we distinguish those aspects of financial management that
pertain to financing, planning, forecasting, and managing a professional
services firm.

Capital Structure
Privately owned professional services firms typically rely on a relatively
simple capital structure consisting of owner ™s equity in the form of owner ™s
capital and retained earnings, leasing of facilities and major capital equip-
ment, and limited bank financing, typically used to help fund working capi-
tal requirements. To manage its limited capital resources well, the firm must
work carefully with its vendors and clients to negotiate payment terms that
minimize the firm™s reliance on outside financing. Brief ly, smart ways to re-
duce working capital requirements and improve the firm™s cash f lows include:

• Invoice clients weekly or biweekly. Although this may conf lict with the
client™s normal accounts payable process, if you can negotiate this type
Finance, Accounting, and Human Resources

of billing arrangement, you should be able to accelerate your cash f low
significantly while reducing total credit exposure.
• Collect A /R in a timely manner. Dedicate resources, including senior
management attention, to collect all receivables within 30 days of the
invoice date, with significant managerial attention on any item over 60
days past due. Inclusion of late payment charges (e.g., interest) in con-
tracts and invoices also may be helpful in accelerating payment.
• Prebill. As described earlier, in certain situations you may be able to ne-
gotiate terms with your clients to bill them based on an estimate of the
actual costs incurred, particularly when the project is large or you will
be procuring a significant amount of goods or services on their behalf.
• Negotiate 45- to 60-day payment terms with vendors. When establish-
ing a relationship with a vendor, particularly if it is one that will be long
term, try to negotiate terms that provide for payment within 60 days,
but no less than 45 days, unless the vendor is willing to grant discounts
for prompt payment. Most vendors will be delighted to work with cus-
tomers who always pay their bills within 45 days without falling behind.
Although the negotiations upfront are difficult, once the vendor agrees
to it and you always make your payments on time, it will be a win/win
situation for both parties. However, if you negotiate delayed payment
terms and then fail to make payment within that period, your firm™s
credibility will be damaged and your ability to negotiate similar deals
in the future will be impaired significantly. When asking for this con-
cession, you must follow through and live up to your word.

Budgeting/Financial Planning
If you don™t know where you are going, any road can take you there.
”Lewis Carroll, Alice in Wonderland

Financial planning is an art that combines historical facts with subjective
assessments of future events to project the firm™s financial performance in
both the current fiscal year and in succeeding years. These future events
could include winning new business, growing existing accounts, losing ac-
counts/clients/projects, adjusting for staff compensation changes, as well as
changes to all other cost components. The key in developing a forecast is
to understand all assumptions, assess their probability of occurring, and
quantify them in the form of both a high level long-range plan as well as a
detailed annual operating budget. The remainder of this section addresses
key planning process methodologies and issues.

LONG-RANGE PLANNING. Long-range planning is the process of setting
forth certain goals and objectives for the firm to achieve over a specific
370 The Back Office: Efficient Firm Operations

period of time. Having a written plan enables management to unite behind a
single set of objectives and provides a benchmark against which their perfor-
mance can be measured. Every firm should have a long-range plan, regard-
less of size that meets the strategic or personal objectives of the owners.
Managers of professional services firms are often so preoccupied with the
state of their relationship with their current client base that they believe any
sort of planning beyond the current quarter is meaningless and a waste of
time. Often it is. However, smart managers acknowledge this paradox but
still press forward in establishing goals for the firm.
Long-range plans (LRPs) may be developed for any period of time, nor-
mally for a minimum of 3 years, often 5, and sometimes 10 years. Obviously,
the longer the term, the less reliable the plan will be, but any of these terms is
useful in quantifying the goals of the senior leadership team. The key to the
development of any plan is to quantify and document realistic targets for the
firm, as well as the strategies the firm will employ to achieve its goals. By
quantifying these goals and strategies in the form of projected financial state-
ments, the firm will also quantify the order of magnitude of its cash require-
ments for working capital in future periods and thus can take action to secure
that funding with as much lead time as possible with the best terms available.
Once developed, the LRP should be updated each year as the initial step in
the development of the annual budget. At a minimum, a well-developed LRP
will include:

• Executive summary (outlining in narrative form the major issues facing
the firm and its prospects for the future, the firm™s goals, and its strate-
gies for achieving those goals)
• Projected income statements (The LRP should be formatted in a way
that maps exactly to the financial statements of the firm to facilitate re-
porting against the plan as well as provide a consistent foundation for
historical trend analysis.)
• Projected balance sheets and cash f low statements
• Key metrics, such as:
”Gross margins percentage
”Revenue per employee
”Operating margin percentage
”Net income as a percentage of revenue
”Staff cost as a percentage of revenue
”Compound annual growth rate (CAGR) of revenue
”CAGR for operating expenses, operating margin, and net income
”Revenue conversion rate (change in revenue/change in operating
margin) for each year
”Current ratio
”Debt to equity ratio
Finance, Accounting, and Human Resources

”Return on equity
”Return on assets
• Capital plan (outlining key capital needs required to support the plan, in-
cluding the type and quantity of equipment needed and cost for new ini-
tiatives, as well as the long-range replacement plan for existing equipment)

ANNUAL PLANNING/BUDGETING. Once the LRP has been developed and
approved, targets for the upcoming year ™s budget will result and, most impor-
tantly, they will have been developed in the context of long-range targets for
the firm. Without achievement of the LRP™s first-year targets, it is unlikely
the firm will be able to achieve its long-term goals. But once those goals have
been established at a high level, the firm can then prepare its detailed annual
budget for the upcoming fiscal year.
Some firms prefer to avoid using the word budget because many managers
assume that they can, and should, spend everything in their budget even
though it may not be necessary, thus leading to higher expenses than ab-
solutely needed. Instead, words such as annual plan, forecast, outlook, first
update, or latest update may be used interchangeably to describe the firm™s
financial plan or budget for the upcoming or current fiscal year. Which term
to use is a matter of management™s personal preference, but they should rec-
ognize that most nonfinancial managers still will refer to the annual plan as
their “budget,” no matter what the firm calls it officially. The remainder of
this chapter refers to the detailed annual plan as the “budget.”
When establishing budgets to which line managers will be held responsi-
ble, it is critical that those managers participate actively in the development
of their departments™ detailed plans. If they do not actively participate in
the process, the numbers they are given may be referred to as “the CFO™s
numbers,” and it is less likely that the manager will buy into the numbers and
ensure that his or her costs are managed accordingly. Situations where
budget numbers are given to managers as their plan are often referred to as
“top-down” budgeting. The best attribute of top-down budgeting is that the
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