January is a pinch point for firms but often highlights existing issues.
VAT, rental payments, the lingering effects of professional indemnity insurance renewal as well as individual partners tax payments due at the end of January means many law firms find it a challenging month as they scrape together enough money to pay all the expenses.
Some managing partners reach January and discover they do not have enough financial resource within the firm to meet the outlays that month and have to find a quick fix to their problem.
Some law firms then decide their business management is done for the year, only to repeat the cycle twelve months later. Each year they hope that the situation is improved sufficiently that they can relax a bit more.
The better managing partners see this interlude for what it is: a warning sign. Those running the more successful firms realise that, without change, it only takes an extended negative period, such as another recession or a bad Brexit, to cause their business to collapse.
- Poor internal financial reporting
- Lack of understanding of work in progress v profits v cash held
- Lack of understanding of their position in the market, where the market is and where it is going
- In some areas a race to the bottom in terms of fees charged
- Misdirected M&A activity
- Over distribution of drawings
These are just a selection of the issues many law firms face on a daily basis. It’s vital that if a law firm is struggling in any of these areas that they develop and implement a coherent plan. Equally important is that this plan is adhered to and maintained, it’s a movable document but it provides structure to all those working on the issue.
Correct costing is crucial
Costing and billable time for work done is a regular problem for law firms, with many firms facing extreme pressures on what can and cannot be charged. Often work done is charged at a flat fee regardless of the hours associated with delivering it. This can result in profit if work is done quickly but often the hours exceed the time quoted.
Alternatively a fee earner can bill per hour (if the client will accept this approach) but then face negotiations on final payment, which can result in in billing a substantially lower amount and an upset or lost client. There is often a failure to monitor the costs being charged due to poor time recording and reporting systems. The fee earner is often left unable to properly justify to the client where, and on what, the time has been spent.
If overall costing analysis shows either method to be marginally profitable this may be fine but such analysis is rarely used.
Business modelling crucial to success
Ultimately these issues stem from the business model and the controls and systems in place to help the team make the correct decisions for the business. The ability for those in charge to make correct decisions about what work is profitable and what work should be turned down is crucial. Analysis of the tender process is a vital component of that: does it work for the business? Does it bring in the right business? Is the business profitable enough?
Developing a realistic and robust business plan is crucial to the success of any law firm but particularly those that are experiencing financial difficulties - let alone planning for such events as Brexit.
For firms encountering issues or looking to positively influence their business model, accurate and realistic cash-flow modelling becomes immediately essential, with reviews against projections each week and, in some cases, daily amendments.
Cash is king
Law firms are notoriously thinly capitalised. Capital can act as a buffer to prevent the business being rocked by turbulent economic storms. A major part of the problem is the delays in which it takes law firms to collect fees for work done.
Our analysis of the most up to date audited accounts of the top 50 law firms [2015/2016] demonstrated that almost 43% of total revenue was locked up in working capital, with clients taking an average of 119.3 days to pay for their work - significantly more than the commercial average, and an increase from 118 days from the year before.
Indeed, in our recent law firm survey, more than half (56%) of respondents viewed an improvement in lock-up as the best way to secure funding for investments in the firm. It is amazing they have not sooner, as the benefits are extraordinary. If a £50m fee income law firm can improve lock-up by just one week, it can bring in around £1m of additional cash.
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 www.smithandwilliamson.com prior to the launch of Evelyn Partners.