One of the most acute and urgent issues facing law firms in this climate of economic uncertainty is cash flow.
The UK is poised for the weakest economic growth in the developed world in 2023, according to new forecasts from the Organisation for Economic Co-operation and Development. With inflation set to reach 10% in the last quarter of 2022 (far higher than average wage rises), the resulting consumer behaviour could severely impact law firms’ cash reserves.
2022 is already proving to be a tough year for many law firms, with income falling by an average of 4% across 25+ partner firms.
As Louis Young, MD at leading litigation funder Augusta commented, “The legal industry in the UK had already started to see growth fall off before the pandemic hit. Partners are under acute pressure to monetise invoiced work, however, it may now be harder than ever for firms to extract timely cash payment from clients.”
With potential delays to client payments and a reduction in billable activity, improving cash flow will be more important than ever to firms. In periods of recession, the SME market often experiences a downturn, however, the demand for some types of legal work increases during periods of recession, for example, restructuring and insolvency matters and employment law.
Reducing lock-up will always be one of the most significant ways for law firms to free up cash.
Across the legal sector, year-end lock-up increased again in the last year, to an average of 137 days (from 125). This reflects the fact that the number of days taken to collect debts increased from 58 days to 65 days, and the average time taken to bill WIP also increased from 67 days to 72 days.
For firms involved in areas like complex medical negligence claims, lock-up can be substantially higher.
Reducing lock-up even by a marginal amount can have an immediate and positive impact on firms’ cash positions. Not only does reducing lock-up free up cash now, instilling better financial practices means firms will be better prepared for the lengthy period of economic uncertainty following the Covid-19 crisis.
The results from the Law Society’s LMS Financial Benchmarking Survey 2021 revealed that on average, firms use 90% of fees earned by a fee earner to cover their costs.
The breakeven point is set to increase, and, despite the impact of Covid-19, salary costs continue to rise. Overheads in many firms have already been cut back as far as possible.
As the LMS survey explains, “Fee income is driven by a combination of fee earner numbers per partner (fee earner gearing), chargeable hours recorded (productivity) and recovery rate achieved per chargeable hour.”
While fee earner gearing is an important metric when the industry is growing, Covid-19 meant that firms have had to look much more closely at fee earners’ capacity for chargeable work and the availability of that work. It stands to reason that the greater the productivity and recovery of fee earners, the higher the income.
Fees per fee earner is a key issue for all firms to focus on, and alongside this there needs to be close monitoring of productivity and recovery rates. If fee earners are not fully time recording both chargeable and non-chargeable time, then it is very difficult to know whether work is being carried out efficiently and profitably.
Billable activity and profit need to be converted into cash quickly during these uncertain market conditions. As Smith & Williamson found, reducing lock-up requires a combination of a change of culture and investment in the right technology. Here’s how law firms can reduce their lock-up period.
The first step to improving lock-up is to understand your own data, set clear targets and monitor performance. The goal can be simple, for example: the time it takes clients to pay invoices after issuing them. Some technology tools give you access to this data in real-time.
While there are some quick wins to be had using technology, ultimately to reduce lock-up you need to change firm culture. Your action plan may include the following:
There are now a growing number of technology tools which can help you reduce your lock-up period. These range from lawyer-facing technology like billing software and time recording, to client-facing technology, like online payment tools.
Legl found that 50% of clients pay their invoice outside of office hours, and that when firms include a link to pay online with their email invoices, clients paid on average within 8 hours. Offering clients the option to pay online means firms get paid faster, while giving their clients a more frictionless and modern payments experience.
Successfully reducing your firm’s lock-up period can equate to 10% more cash in the bank.
How would you best utilise this cash in your firm?
One way to use this cash is on tech. Law firms are increasingly recognising the benefits of tech – besides the obvious purpose to cut costs. 92% of law firms indicated that they are planning to adopt a greater use of technology for purposes other than to cut costs – making it the number one strategy to improve overall firm performance.
Gartner highlights adoption and investment of legal technologies in some of the following areas:
of law firms don’t have enough cash to cover one month’s operating expenses
is the average number of days it takes for an invoice to be paid across UK law firms
of law firm clients expect to be able to pay their invoice(s) online