The majority of UK law firms have a March or April year end, so we can now access information on their 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.
With the vast, sudden uncertainty created by the pandemic, law firms recognised the need to act quickly. Improvements were made to the time it takes clients to pay, partner distributions were withheld and law firms made use of various forms of Government support such as loan schemes, deferred tax payments and the furlough scheme. In many cases, this was enough to see them through any revenue fallout.
Perhaps the only lever not pulled by law firm management was an increase in partners’ capital, most probably because this would take time to put in place and perhaps that it was felt any cash crunch would be temporary.
A year on from that troubling and uncertain time, have these decisions proved correct? The superficial answer appears to be yes, as none of the top 50 law firms has suffered an insolvency event (it is easy to forget some of the dramatic predictions being made twelve months ago) and a review of the audit reports covering 2019/2020, signed off later in the pandemic, shows that only one firm’s auditors emphasised the impact of the pandemic in their audit report.
However, on reflection, should law firms have been better prepared? Revenue for the top 50 law firms of £19.5bn is generated from a members’ capital contribution of (only) £4.8bn and (an improved) cash position at year end of £2.4bn. These figures need to be read in the context of a monthly wage bill for the top 50 firms (ignoring partner drawings) of around £700m.
As the pandemic struck, a number of firms, as has widely been reported, took advantage of the Government furlough scheme. It is doubtful whether the Chancellor had the legal market in mind when he announced the scheme and one could reasonably ask whether the highly profitable and cash generative legal industry should have been able to look after itself (cash inflow from operations for the top 50 firms in the 2019/20 year was £5.8bn).
Alternatively, would law firms have made people redundant had it not been for the furlough scheme? Performance turned out better than expected for a number of firms, who have subsequently – and honourably - repaid the furlough money they received.
In a world where shocks from global markets, banking crises, conflict, Brexit and now pandemics seem to be becoming increasingly regular, perhaps firms should be more self-reliant. Government support may not be forthcoming every time, particularly with a vast debt burden.
The tools for greater self-reliance are right under the noses of law firm management. At their year ends the top 50 law firms had almost £5.9bn of unpaid client invoices on their balance sheets or the equivalent of 113 days of work. If firms were able to reduce this to say 75 days (i.e. clients pay on average after 2.5 months), it would generate an additional £1.9bn worth of cash for the top 50 firms. Put another way they would then have enough cash on their balance sheets to cover three months of employee wages, making them vastly more self-sufficient if - or rather when - we experience the next shock.
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.