In common with many other sectors, law firms faced a potential cash crunch from the Covid crisis. The early part of the pandemic saw law firms take drastic action to shore up their cash positions in the face of sliding revenues.
The majority of UK law firms have a March or April year end, so we can now access information on the performance and financial strength for the year to the end of March/April 2020 of the top 50 firms, just as the pandemic started significantly to impact everyone’s lives.
Revenue over this period increased by 4.3%, the second lowest annual increase in the last seven years and with salary costs increasing by 7.6%, the operating profit margin fell below 30% for the first time in seven years. The sudden nature of the pandemic appears to have hit firms’ revenue in the last few weeks of their financial year, but firms were unable - in such a short period - to mitigate any costs.
Instead, firms strengthened their financial position by cutting partner distributions and calling in debts. Cutting people costs takes time to organise, implement and see the benefits come through whereas reducing partner distributions has an immediate effect.
Lock up in the form of debtor days fell 4.4% to an average of 113 days. This improvement generated on average an extra £6.6m per firm of cash on their balance sheets. Sadly, this dramatic increase only goes to show what could be achieved if the, still woefully poor, 113 days was reduced to, say, below 100. Even at 100 days, this would mean that an invoice raised on 1 January would not be paid until the second week of April.
Through various measures, by the year end (either March or April 2020 in most cases) the average cash balance of a top 50 law firm stood at £48.7m, an increase of 57.3% over the prior year. This represents the most healthy cash position for law firms in the last seven years and possibly for a generation.
Other sources were also used, with the average amount of bank loans and overdrafts increasing to £21.9m from £16.5m in the prior year. However, members’ capital fell 1.6% over the same period despite an increase of 2.9% in the number of members. Capital calls on members takes time to plan and organise and the fact that this approach was not used supports, firstly, the sudden nature of the pandemic, but perhaps also that most firms saw any potential cash flow impact to be temporary.
Time will tell whether this was the correct decision, but in light of the immediate and sudden nature of the pandemic, firms did appear to respond promptly to protect cash, ensuring they were better placed to deal with the huge uncertainty ahead.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.