June 12, 2008
Forecasting Collections and Inventory Management
In today’s unstable environment, driven by outside economic forces, higher associate salaries, and increased competition, law firm leaders are faced with the tough job of forecasting cash collections. Many existing forecast methodologies focus on production and collection realization. However, these models often fall short because they ignore the other drivers of collections, and do not provide any information about collections beyond the forecast period. A better model:
1) Forecasts bills and collections as they relate to inventory levels thus allowing analysis into the impact of the next period’s collection funnel,
2) Drives the forecast according to the speed of the billing and collection cycle,
3) Isolates the quality of inventory separate from collection timing by analyzing realizations at the time of collection.
A key aspect to understanding collections is to think of the process as an inventory funnel. Each month production is added to the funnel, increasing inventory available to bill and collect. At the same time, bills and collections, as well as write downs and write offs drain the funnel, thus reducing inventory levels available next period. By analyzing this inventory turnover, modelers can focus on the drivers of collections: beginning inventory, production, inventory turnover, and realizations. Consider the following example:
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Last Year
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Forecast
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Beginning Inventory
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$50,000
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$60,000
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Production
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$150,000
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$170,000
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Total Available for Collection
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$200,000
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$230,000
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Written down/off
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$10,000
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$11,000
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Cash Collected
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$130,000
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$150,000
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(3)
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Inventory Turnover
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$140,000
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$161,000
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(4)
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Ending Inventory
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$60,000
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$69,000
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Inventory Turnover %
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70%
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(1)
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Realization %
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93%
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(2)
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1) Inventory Turnover/Total Available for Collection
2) Cash Collected/Inventory Turnover
3) Total Available for Collection * Last Year’s Inventory Turnover %
4) Inventory Turnover * Last Year’s Realization %
In this model, the total available for collection is beginning inventory plus production. By comparing the amount available for collection and the ending inventory, the modeler may derive the inventory turnover. Also, by looking at the type of turnover, collected vs. written down or off, the modeler can calculate realization. Applying Inventory Turnover % and Realization % to future inventory, produces a cash collected forecast based on all of the cash drivers mentioned above and provides a starting point for the next period.
Redwood Analytics has helped law firms forecast collections using this and other methodologies since its inception. Our Business of Law Consultants are prepared to help law firm leaders take their forecasting to the next level by sharing best practices forecasting techniques, separating inventory turnover for billing and collection cycles, and capturing the seasonality of collections. In addition, our business intelligence solution is uniquely positioned to help law firms not only improve their forecast, but also their actual results.
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Filed under Cash Flow Issues, Forecasting by Rick Rawls
Comments on Forecasting Collections and Inventory Management
Stark County Law Library Blog @ 9:07 am
"Forecasting Collections and Inventory Management"…
Posted by Rick Rawls: In todays unstable environment, driven by outside economic forces, higher associate salaries, and increased competition, law…