Lock-up continues to increase. Law firms remain poorly insulated against any major shock to the economy.
On the face of it, the legal market appears in rude health, with the top 50 firms generating revenues of over £17bn. Operating profits rose 8.1% last year. Partners may congratulate themselves for a job well done.
However, this ignores the perennial problem of lock-up. Debtors were up 9% on last year, with £5.7bn billed but not paid and a further £2.1bn uninvoiced (up 17% on the previous year). These figures continue to worsen year on year.
Of course, if a firm has lawyers working on client matters, they still need to be paid, whether clients have paid or not. The total monthly wage bill for the top 50 firms stands at £610m, yet these firms have net cash at their year end of only £410m. If clients stopped settling outstanding invoices from the beginning of the month, on average firms could only afford to pay staff until around the 22nd of the month.
A shock to the system?
What might stop clients paying their bills? Any form of Lehman’s style shock to the system could create problems. This could come in the form of a ‘no deal’ Brexit or a significant economic downturn. These events are often poorly sign-posted and law firms may not recognise the problem until they’re in the thick of it.
Equally, there may be specific risks in certain vulnerable sectors – retail, for example, or other industries subject to disruption. The longer companies take to pay, the longer the risk that they will get into difficulties in the interim.
We see real difference between individual firms. Long-term work in progress and slow payment have always been challenges in litigation, therefore litigation firms tend to be better prepared. However, we see many major firms that are thinly capitalised, leaving them vulnerable to external shocks.
Building a cash buffer
If just 10% of bills were paid earlier, firms would double their cash reserves. If all firms lowered debtor days by just seven days – there would be another £352m of cash on balance sheets in total. Partners seem slow to respond to the problem and it appears to be getting worse year on year.
In a benign environment, the model works, but firms should be building in a buffer for more volatile times. Even if the economy continues to tick higher, the lack of cash means that firms may be missing the opportunity to reinvest in technology or other efficiency improvements, potentially to the detriment of the service they offer to clients.
Source: Companies House. Data analysed May 2019.
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This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.