Cut the lockup cost

The annual survey of solicitors’ firms in Scotland is the largest representative survey undertaken by any law society in the UK and may well be the largest in Europe. Each year, valuable data are generated on the comparative performance of firms of different sizes and in different locations. Arguably, however, some of the most useful relate to the amount “locked up” in working capital and the money needed to fund the firm.

Capital needs

A firm’s working capital – the amount tied up in unbilled work, debtors and outlays – is funded by a combination of partner capital and bank borrowings. In the future, as is already happening south of the border, funding may also come from external investors. For example, already this year we have seen a £150 million private equity investment in personal injury firm Parabis, the purchase of Liverpool firm Silverbeck Rymer for £20 million by Quindell Portfolio, and the acquisition of Russell Jones & Walker by New South Wales listed firm Slater & Gordon for £54 million. For now at least, for firms in Scotland there are just two sources of funding – the partners, and the bank and other lenders.

The amount of capital that is needed will depend on a number of factors including:

• the type of work undertaken – some firms need a higher total amount of capital than others. For example, a firm undertaking pursuer personal injury – especially for unions – will have a higher working capital requirement than one doing residential conveyancing;
• the firm’s structure – firms with high levels of gearing normally need higher capital per partner, as a smaller pool of partners have to fund the working capital of a larger number of non-equity partner fee earners;
• how quickly fee earners bill their work;
• how good the firm is at getting paid.

This year’s survey showed a reduction in bank borrowing on the part of firms and an improvement in the bank position of most firms, as shown in chart 1. It may well surprise many readers to see that relatively few firms operate on an overdraft.

The improvement is likely due to better control of the amounts owed by clients, and reductions in the amounts tied up in outlays.

Debtors have fallen from a median of £8,500 to £7,500 per fee earner, as shown in chart 2. This could be due to better financial control, or lower work levels.

Chart 3 shows debtor days, which is a measure of how efficient firms are at collecting their debts – and this also shows a reduction, suggesting an overall improvement in cash collection and credit control.

Chart 4 shows further reductions in outlays per fee earner.

Cashroom controls

The cashroom partner has an important role to play in minimising the amounts tied up in working capital. In particular:

Ensure your cashroom produces reports of debtors, work in progress and bills, promptly at the end of each month, certainly within the first two or three days. Distribute the detailed reports as appropriate to fee earners.

Design a one-page summary that reports the main figures from these detailed reports, the totals and key measures. Maybe use charts, and give comparisons over the previous six months.

Focus on a small number of key figures such as:

• debtor days – which is an effective and simple way of assessing whether the amount tied up in debtors is too high;
• amount of debtors over two months old – the areas where you are most at risk of bad debts;
• WIP days;
• amount of unbilled outlays;
• daily cash collections.

Explain the importance of monitoring these areas to (a) your partners, (b) your other fee earners, and (c) your support staff, and decide what information can be circulated to each group. Distribute as much as possible – your staff have as much interest in the firm getting paid as you do. Some firms will distribute the summary to all staff via the staff notice board. The cumulative cash collection for the month to date would be updated weekly or even daily. There is nothing especially confidential and the key is to get everyone focused – remember, what gets measured gets targeted.

If your firm does not time-record, start doing so – it is your best way of keeping track of what everyone is doing and where their time is going.

The table opposite explains how to calculate debtor days, and assumes that at the end of January total debtors were £270,000, including VAT.

The table below takes the total debtors at the end of the month, excludes VAT and then deducts each month’s fees until zero is reached. It is a simplification to say that all of January’s fees are outstanding, and you must resist the temptation to overcomplicate this calculation. However, to focus on a single figure is a very powerful way of focusing minds.

In the report we calculated this figure by dividing year-end debtors by each firm’s average daily fees. Because most firms that undertake legal aid only post their legal aid bills when they are paid, average daily fees exclude legal aid fees. You need to ignore work on a cash basis in this calculation.

Be upfront

Remember, 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.

Be 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 in the last few months.

Send regular interims – monthly if the matter is significant, quarterly for all other matters. Clients prefer to know where they are; it avoids surprises at the end; and of course it helps your cash flow.

If and when it is clear that the fee will exceed an earlier estimate by a meaningful amount, tell the client – do not leave it until the end when you submit the final fee note.

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. 

Taking part: the benefits

All participating firms receive a free copy of “The 2011 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 2012 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. In 2011 the £700 prize was won by Frances McCartney of Patrick Campbell & Co, Glasgow. The Society is again grateful to Alex Quinn and Partners for sponsoring the prize in 2011.