UK firms’ financial hygiene failure costing a “treasure trove of cash”

UK law firms are “sitting on a treasure trove of cash” that they are not accessing because of failures in basic financial management.

This is one of the key findings of the UK200: Financial Management 2016 report, which this year includes borrowings and total lockup data from some 130 UK firms.

While the results indicate clear signs that a number of firms are becoming more efficient in terms of financial hygiene, the overall market trend is for the legal sector to lag significantly behind other professional services.

Smith & Williamson partner Giles Murphy said he was not convinced that UK law firms in general were significantly improving their financial management, adding that in comparison to many firms’ clients the legal sector was significantly less efficient in billing and collecting fees.

Murphy said that while the industry benchmark for total lockup, which consists of work-in-progress (WIP, or accrued income) days and debtor days, is broadly seen as 110 days, this still represents well over three months before some firms are collecting fees.

“If your lockup is three and a half months it means you’re paying for the cost of the rent, salaries, electricity and so on before your clients pay you,” said Murphy. “If you consider that some corporate deals will pay on completion, meaning lockup days for these are virtually nil, it suggests that in other areas of a firm’s workload it’s going to be around six months. Who would set up a business model like that? But it’s become the norm.”

Murphy believes that there has been “some improvement” in the legal market but it is “at the margins”.

“There is such a massive opportunity to change the structure,” Murphy added. “Why isn’t firms’ WIP zero? Some businesses operate with negative WIP, for example if you have a £50,000 project, you can invoice half up front so on day one you have negative WIP. And why shouldn’t you? You’re incurring all the costs. Saying this to firms smokes out whether or not clients are really up for it.

“Lockup management isn’t something you focus on for a couple of weeks and then it goes away, it’s a constant war of attrition,” insisted Murphy. “That’s why you employ people to do it. It’s dull, boring, the initial results are poor, and partners whinge and moan. But as the age-old comment says, firms don’t go bust because they’re loss-making, they go bust because they run out of money. And they’re sitting on a treasure trove of cash that they could unlock and it’s all within their control.”

Murphy was also dubious that most firms were utilising their business services teams to the full extent possible, despite noises to the contrary.

“People talk a good game but the reality is often very different,” claimed Murphy. “Quite a few firms have good credit control teams in place. But if these teams have to check with a partner first that it’s ok to chase a bill, and then the partner says ‘oh, leave that one with me’, then more often than not nothing happens. The credit control team needs to do their job, and the more you can get the fee-earners away from the billing the greater the likelihood that you can employ experts who will do the job properly. Too many firms are paying lip service to this.”

Grant Thornton partner Peter Gamson echoed Murphy’s comments, claiming that many firms are nowhere near as efficient as they could be in terms of financial management.

“The legal market in general is still is way off the pace when compared to the level of discipline corporates apply in this area,” said Gamson. “Law firms with significant lockup will often debate the challenges they face and how they aren’t managing to alter behaviour in a sustainable way, but then not use support or rigour to seek to change the situation, typically choosing to give it a go themselves. It is a huge missed opportunity as there is so much cash they could release if they embraced expert insight but many just don’t grasp the nettle in the way that most corporates do.”

This year for the first time The Lawyer asked firms not only to provide details of lockup at year-end but also to provide data on the firm-wide average throughout the year. This extends the collected data away from simply focusing on the year-end, which as Gamson points out can skew results.

“With any metric if you just look at one moment you’ll get a distortion, a spike,” says Grant Thornton partner Peter Gamson. “Looking at an average can give you a much better impression of how a business is run.”