Law firms emerging out of the recession

It is often said that more businesses fail as the economy emerges out of recession than whilst it is in recession. The main reason for this is that those businesses may be profitable, but they run out of cash. That is particularly poignant for many law firms at the present time.

Most firms have been adversely impacted activity-wise first by the credit crunch and then the recession. Transactional services have suffered the greatest reduction, but other work types have also struggled, particularly those with an element of reliance on those transactional services such as family work or probate. Many of those firms have re-aligned their staffing structure to reflect the reduced workloads and they are now seeing the benefit, profit-wise, of taking those difficult decisions.

The greatest impact on law firms, however, has been on cashflow since:

  • the mix of work types within practices has moved more towards matters with longer lock-up periods and away from the traditional ‘cash-cow’ area of residential conveyancing
  • matters have taken longer to complete
  • payment terms have been extended and firms have suffered more bad debts
  • drawings may have continued at levels based on prior period profitability
  • delayed taxation payments based on more profitable prior periods have coincided with the downturn

Many of those issues are still relevant today as the economy is emerging from recession. Activity levels are beginning to increase in certain areas and the firms that downsized may need to take further difficult decisions on whether or not to recruit. Firms will want to make an investment for the future and not suffer seemingly false economies by saving money today that will cost them tomorrow. The key thing, however, is to make sure that there is a tomorrow.

As activity picks up, firms are automatically making an increased investment in the future – in terms of their working capital. There will always be fixed costs to cover, but marginal costs will increase as new matters are taken on, and working capital is required until those new matters complete, they are invoiced and the invoices are paid. This, in the short-term will use more cash, which is already in short supply.

What can be done?

It is vital to have robust management information systems. The regular production of accurate management information is as important as ever as your early warning system. The information produced must contain cash flow forecasts, and these need to be prepared regularly in order to show the future cash needs of the business. Cash-flow requirements need to be calculated in advance so that you are aware of the peaks and troughs. This will allow decisions to be made to cut costs or obtain additional finance before any cash-flow problems occur.

This will also allow you to work with your lenders; the advance notice certainly helps them and it gives them more confidence to support you. They are much less likely to help if they receive a last minute request. The banks are being quite harsh with many businesses in the current climate, particularly solicitors, but they are much more likely to support you if you can get them ‘on side’ with what you are trying to do. If you have not done so already, or if the bank hasn’t requested it, it would be a good idea to arrange a meeting with your bank to outline your business plan and forecasts to show them how your firm will emerge from the recession.

It is also important to monitor activity levels and new instructions. Doing so will help with preparing the forecasts, but it will also show how busy the fee earners are. Monitoring the level of new instructions will also help you to make the appropriate decisions in terms of how many fee earners are required.

To help further in this regard, I would suggest that all fee earners in all departments should record all of their non-chargeable and chargeable time by matter. Many firms have told me that this is not necessary when doing fixed fee work such as conveyancing. I have always recommended that this should be done so that profitability can be calculated by job and by department. It also means that fee earners work more efficiently as they know that they will be judged on each matter. Now it is an absolute must. You will need to know how much time is being spent by fee earners on chargeable and non-chargeable duties. You will need to know what the recovery rates are for each matter, fee earner and department. This information will allow you to make the right decisions in effectively managing your practice.

It is also important to monitor profitability by department. I am doing a lot of work at the moment with law firms to help them to accurately calculate this and then benchmark it against the results of other firms. This is helping them to make strategic decisions about the future of their firms – should costs be cut in under- performing departments? Is additional investment required in certain departments? Would it be better to stop performing certain types of work?

Credit control

The credit control function is vital at this time. Aged debts need to be monitored; you cannot allow them to become overdue. It is the older debts that are more likely to default. The longer a debt is left outstanding, the smaller the likelihood of recovering it. In some circumstances, it may be appropriate to offer discounts for early payment.

Debts should be chased on a regular basis and all members of the team need to keep their eye out for clients in difficulty. It may be that clients that have been good payers for a number of years are now slowing with their payments, or are not returning calls; these are indications that they could be struggling and a determined effort needs to be made to collect the debt and consideration should be given as to whether additional work should be carried out.

When new instructions are taken, clients should be asked to make up-front payments on account of costs. This is usually done for conveyancing matters, but this should be extended to all work types wherever possible. All fee earners in all departments need to be encouraged to bill more regularly on account, rather than waiting for the end of the matter. This could be particularly helpful on matters where you hold client money such as probate. At the end of the matter, the final bill should be issued promptly whilst the client still values the work that has been carried out and is therefore much more likely to pay.

When instructions are received from new clients, consideration should be given to obtaining credit references. This may not be necessary for all clients and all work types, but it will be important in an increasing number of cases. It may be that another firm has stopped acting for the client because they stopped paying their invoices.

Credit limits should be set for all clients. These should be reviewed regularly and the limits should not be exceeded. Work should stop if debts are outstanding and there is a chance that they may not be paid. If work continues, the problem may just become worse.

I also think that it is important to have a separate credit control function. Often the fee earner is too close to the client to effectively chase the debt; they do not want to disturb their relationship and do not want to risk not receiving future instructions. A credit controller is more skilled in debt collection and can enable the fee earner to maintain their relationship with the client.

I have had many discussions recently with lawyers regarding the best method of credit control. Some people say that written warnings are best, but I feel that this sometimes helps clients to avoid the issue. Speaking to the client over the telephone means that they are less likely to avoid the issue, it allows you to understand why they have not paid, it helps them to understand your position and you may be able to discover whether there is a real problem behind the lack of payment. I also feel that it is more likely to improve your relationship with the client in the long-term.

Lock-up

Minimising the lock-up of unbilled time and disbursements is the cheapest form of finance available. As discussed above, bills should therefore be produced much more frequently; it may be advisable to diarise regular slots for billing. Once bills have been issued, and there is available money in the client account for that client, the transfer to the office account should be made as soon as possible. Consideration should be given to automatic transfers on billing and reviews should be undertaken on a daily basis to discover if any amount can be transferred.

When performing SAR reviews, I often find breaches of Rule 19(3) where it has taken more than 14 days to transfer available client money from the client account to the office account after a bill has been issued. I have always been more concerned with the commercial effect of this rule breach on law firms rather than the breach itself. Now it is as important as ever to make the transfers as soon as possible.

Daily reviews should also be undertaken for amounts that can be transferred from the client account to the office account for disbursements. Once a non-professional disbursement has been incurred, or a professional disbursement has been paid, the amount can be transferred to the office account immediately.

There are also other commercially beneficial options that are available, in compliance with the Rules, that firms don’t often take advantage of.

Conclusion

Everybody within the practice needs to be aware of the issues that the law firm is facing. They can all have a real impact on other members of the team in other departments. As discussed above, chasing debts may not be the responsibility of fee earners, but there are many things that the fee earner can do to make it easier for debts to be collected. By acting as a team, being aware of the issues, communicating with and helping each other, firms will be much more likely to emerge out of the recession and prosper.

If you would like further advice on your particular circumstances or a review designed to improve your lock-up procedures, please contact Andy Poole at andy.poole@armstrongwatson.co.uk

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