When cash is king

As discussed in last month’s article, the 2009 Cost of Time Survey indicated reduced profits amongst the 233 participants and, because the average year-end in the survey was 31 December 2008, further falls may well occur in this year’s survey.

The rapid decline in activity levels during 2008, and in particular the abrupt slowdown in the property market, caused many firms real cash difficulty that lasted throughout 2009 and can be expected to continue through much of 2010. Cash management is going to be ever more important.

Firms obtain funding from two sources – bank finance and partner capital. The first chart indicates the changes in firms’ bank balances over the last six years.

The chart indicates relatively small movements in the median bank balance but larger changes in the quartiles. Two years ago a quarter of firms had bank balances greater than £62,000 – in this year’s survey that figure was just £43,000, and by now it is likely to be even lower. Similarly a quarter of firms had relatively small overdrafts of just £2,500, whereas that figure is now over £16,000. These relatively small changes will disguise much larger movements for individual firms.

In the balance

The second chart indicates an even greater change in partner capital. This indicates a 27% fall in partner capital compared to the previous year.

This will be due to reduced profits but also difficulty in reducing partner drawings – the net effect being a reasonably significant reduction in partner capital. It is likely this will have fallen further during 2009.

Hopefully 2010 will see a gradual improvement in profitability. However a firm’s bank balance is the result of a number of factors:

• how quickly your fee earners raise their bills – something most have become much better at over the last two years;
• how good the fee earners are at collecting money in advance in respect of outlays so that the firm does not have to fund them;
• how quickly the firm gets paid by its clients;
• whether the partners’ drawings are in line with the profits being generated;
• whether capital expenditure is being properly financed, through long term borrowing as opposed to out of the overdraft.

Funding the upturn

One area of concern regarding cash is how new fee earners might be funded when work starts to improve. Initially, as volumes of work grow, there will be much slack that can be taken up by existing fee earners. However a particular issue for some firms will be at what point they should recruit additional fee earners and how these people will be funded. The reality is that it can take several months for a fee earner to be self funding and in the meantime they have to be supported by the partners. Normally the only way this can be done is by ensuring that cash collection for the firm’s other fee earners is good and that there is minimal inefficiency in the billing and collection process. Good techniques can be:

• reporting and monitoring each fee earner’s debtors, outlays and, if the firm time-records, work in progress. Where there is more than one fee earner in a department this can often be a useful way of highlighting people who are better at collecting the cash – and perhaps their working practices can be followed by their colleagues;
• taking care to ensure that the initial engagement letter is clear regarding payment terms and that fee earners bill their work in accordance with it;
• helping fee earners to recognise when they are moving beyond the scope of the initial work and having the courage to tell the client.

As work levels do start to rise, it is also important to monitor workloads and ensure fee earners do not become overloaded. Historically the most successful firms have been those whose fee earners have reasonable but not excessive caseloads. They are able to do their work well, on time and invariably finish up with satisfied clients who are more likely to recommend. They also make fewer mistakes and have fewer complaints against them. It can be useful to:

• hold monthly team meetings of the fee earners;
• discuss caseloads as one of the agenda items – who has capacity to take on new work?
• use these meetings to discuss marketing ideas;
• use these meetings for technical updates;
• ask each fee earner to bring a “problem” file – they might get some ideas on how to deal with it.

Credit control from the start

Last year we highlighted a number of basic points to remember with regard to cash management that bear repetition – in particular remember that your credit control system starts with your initial engagement letter. You might be delighted to have the client, but you need to be clear about the money – and your client will respect you more for being so.

• Ensure you are clear in your initial engagement letter about likely fees; that you will issue interims; that you will issue your final bill promptly; that you will expect payment within x days.
• If it is a commercial client check their credit rating. If it is a longstanding client check it again, as it may have changed from last month.
• Send regular interims – monthly if the matter is significant, quarterly for all other matters. Clients prefer to know where they are, and it avoids surprises at the end, and of course it helps your cash flow.
• Bill promptly at the end of the matter and let the client know it is coming. The fee earner should speak to the client and explain if the bill is different to what has been discussed previously.
• Let your cashroom chase for payment. Don’t interfere or hamper them.
• Do everything you can to avoid bad debts. Any increase in bad debts will come straight off your bottom line profits.

These basic points will be important throughout 2010. Remember that firms can get into difficulty not due to lack of profit but due to lack of cash. You need to ensure you are not one of them and make sure that cash collection and management is something that all your fee earners and staff think about. It is key to survival.

• Andrew Otterburn is a management consultant and has advised around 250 firms on their management and profitability. He has helped in the development of the Cost of Time Survey since 1999. Author of Profitability & Law Firm Management (Law Society 2007), his new book, From Recession to Upturn – financial management and strategy for law firms, has just been published by the Law Society of Scotland. Together with Fiona Westwood, he is a founder member of the Law Consultancy Network, a network of independent law firm consultants.

• Dr John Pollock, a consulting actuary, has been responsible for the administration and statistical aspects of the Cost of Time Survey since 2002. John is well known to personal injury, employment and family law solicitors in Scotland through his expert witness work at Pollock & Galbraith Consulting Actuaries.

Taking part: the benefits

All participating firms receive a free copy of “The 2009 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 2010 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 Claphams in Glasgow. The Society is again grateful to Alex Quinn and Partners for sponsoring the prize in 2009.

For charts and diagrams please refer to magazine or download the PDF.