Prepare for the upturn

The 2008 Cost of Time Survey provides a snapshot of the health of the profession before the onset of the economic slowdown. The average year end was December 2007, with a quarter before July 2007, so it is no surprise that the survey indicates good results with the median profit per partner for the first time exceeding £100,000. Since then the economy has of course changed completely, and with it the financial outlook for most firms.

Across the UK there have been some dismal press headlines concerning law firms, and these are likely to continue as more firms report their results. The point to be very conscious of is that a relatively small decline in fees can have a huge impact on profits – and cash – because fixed costs largely stay the same. For some firms there will be an added issue regarding their accountant’s ability to sign off their LLP accounts on a going concern basis due to uncertainty over bank funding.

Back to basics

The natural reaction of most firms to the recession has been to cut all unnecessary expenditure and reduce staff levels. Some firms will have concentrated their attention on this need for cutbacks and will have spent less time on the equally important issue of outstanding debtors and outlays, and on their systems for billing and getting paid. It is worth repeating the basic message of our last article, that the really important areas to focus on first concern working capital – debtors, outlays, work in progress – and cash. Most firms need to become much better at collecting their debts, in particular any old ones, and putting in place systems to ensure that, going forward, bills are paid promptly. You need to make sure you become very good at cash collection.

Although this might sound straightforward, in practice for many firms this will be difficult to tackle. Most solicitors dislike discussing money with clients, and hate having to chase for payment even more! There can be particular difficulties with commercial clients, especially when matters are put on hold or collapse; however the principle has to be that firms need to adopt a more commercial approach to billing and payment.

For most firms the two times of the year when cash is under greatest strain are when partner tax has to be paid in January and July. For some firms these will coincide with VAT quarters and rent payments, and for a few the combination will push them into difficulty. To minimise the risk, areas to consider will include:

• adjusting partner drawings to the lower levels of profits you are now forecasting;
• retaining part of these drawings within the firm to cover partner tax;
• transferring an amount each month into a separate deposit account in respect of partner tax, so you have the money already put to one side;
• transferring an amount each month in respect of VAT so once again you have the money put to one side each quarter. (Very small firms may also wish to discuss the merits of the flat rate VAT scheme with your accountants: see www.hmrc.gov.uk/ vat/account-flat.htm#6.)

The key is to tackle these areas before your bank tells you to. You should also avoid any partner current accounts becoming overdrawn – insist that any overdrawn balances are rectified – and keep in touch with your bank. Make sure they know what is happening.

Time to look ahead

When looking at areas for possible cost saving, the Cost of Time Survey provides some useful benchmarks. The charts from the 2008 report shown below indicate that non-salary overheads were typically running at around £34,000 per fee earner or 27% of fees, although both of these figures will increase as fee earner numbers are reduced.

In the February Journal, Richard Henderson made the point strongly that a time will be reached when the recession ends and the economy starts to recover. That may well coincide with greater competition in the lead up to alternative business structures so, once you have your firm’s cash position under control, you should start turning your thoughts to the financial structure and shape of your firm going forward. You need to take stock and reassess your business strategy. In particular, whilst overheads per fee earner of £34,000 may have been acceptable in the past, you might need a much lower figure in the future in order to be competitive – possibly half that level, or less.

There are two issues – the level of your overheads in total and the amount per fee earner, which in turn depends on staff levels.

A perspective on overheads

When looking at the overall level of non-salary overheads it can be useful to group overheads into three categories:

• fixed or relatively fixed – e.g. rent, council tax, depreciation
• variable but necessary – e.g. telephones, stationery, insurance
• variable but discretionary – e.g. marketing, training, IT, external advice.

The latter group are frequently the first to be cut in an economic slowdown, yet they are arguably areas that should be increased – indeed some firms have. They are trying to build new areas of expertise, developing new marketing and business development ideas and using the opportunity to take stock of their firm and reassess the way forward. Most firms spend a very small amount on training and marketing – typically less than 1% of their fees – yet by cutting these areas they are doing maximum damage to their firm in the longer term.

The bulk of non-salary overheads comprise the first two groups. Many, such as rent, council tax and depreciation are fixed, at least in the short term. Fixed overheads might amount to 10% of fees, possibly more. The major part of non-salary overheads for most firms is therefore in the second group – variable but necessary.

This is an area where it can be useful to spend some time, and normally there are three aspects to consider:

Cost reduction. In the past most firms have not spent much time getting good prices from their suppliers, but by obtaining quotes and actively seeking value for money it may well be possible to save 10%, perhaps more. Start with the items you spend most on and seek to negotiate better prices – A4 paper, envelopes, notepads, counsel pads, insurance, telephones, accountancy, etc… If the local supplier appears expensive you might get a better deal on the internet. Adopt a policy to: never accept the first price quoted; never sacrifice quality for price; and always get at least three competitive quotes for any major purchase.

Review working methods – to eliminate wasteful processes and working methods – in particular amongst fee earners. This would include the use of IT within the firm, levels of fee earner, use of support staff and ways of reducing unit cost.

An understanding of the hourly cost of your fee earners, and other key figures such as overheads per fee earner.

The overall objective is therefore twofold – first stabilise the business, in particular cash and working capital, then take stock and start to reposition your firm for the upturn. As Richard Henderson says, it will come, and you need to ensure your firm is well positioned and ready for the very different legal world we may then be in.

• Andrew Otterburn is running a series of seminars for Update that build on these articles and explain in more detail the actions firms need to be taking at the present time: 30 April, Dundee; 21 May, Glasgow; 4 June, Edinburgh. Further details at www.lawscot.org.uk/update .

Taking part: the benefits

All participating firms receive a free copy of “The 2008 Survey of Law Firms in Scotland”, the detailed report upon which this article is based. They also receive a free confidential individual report. Other firms can obtain a copy of the full report, which contains a wide range of useful statistics and performance indicators, from the Professional Practice Department at the Society on 0131 476 8164 (mail to: profprac@lawscot.org.uk).

In April the President will be writing to all firms inviting them to participate in the 2009 survey. Participation is free and carries a three-hour CPD credit as well as an individual report on cost rates in the firm and a copy of the survey report. In recent years there has also been a prize draw. Last year the £700 prize was won by A J Bisset of Connons in Stonehaven. The Society is again grateful to Alex Quinn and Partners for sponsoring the prize in 2008.