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UK law firms failing to see 'red flags' of insolvency

Warned to better manage lockup days and working capital   

28 August 2013

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By Manju Manglani, Editor (@ManjuManglani)

UK law firms are risking insolvency by poorly managing their finances, accountancy firms have warned. 

Working capital management continues to be a problem, with lockup exceeding 150 days in some firms and many taking over 60 days to collect on bills delivered, according to a survey of mid-sized and small law firms. 

Crowe Clark Whitehill (CCW), which conducted the survey, has warned that failure to manage cashflow may be an indicator of deeper issues within firms. 

Baker Tilly has also noted that many law firms are in serious danger of going out of business this autumn because they don’t have sufficient cash to meet their running costs. 

The comments by the accountancy firms follow revelations by the Solicitors Regulation Authority earlier this year that 30 top-200 UK law firms are in serious financial difficulty

‘Widespread’ risk of financial failure

“Many partners assume that, as their practice has come through the recession and profits are stable or improving, they are safe. But if a practice doesn't have sufficient cash to meet its running costs, then there is a real risk of firms failing. I fear that the issue is more widespread within the legal sector than people would imagine,” said Rowan Williams, head of the London and South professional practices group at Baker Tilly.

“I firmly believe that too many partners are unaware of whether there are any serious financial issues within their practice, and don't understand the personal consequences if their business goes under.

“In my experience, law firms ask for help too late, after things have seriously taken a turn for the worse, which is usually about six months before failure.

“It’s going to get tougher for law firms, and if they don't identify the red flags early, then the legal sector will indeed face the predicted 'perfect storm' with many becoming insolvent this autumn.”

Nigel Bostock, London office managing partner at CCW, has also voiced concerns over the financial position of UK law firms. “The number of lock up days is troubling, especially in a challenging market where we are seeing many firms struggling to access finance.” 

Audit partner Steve Gale has suggested that continuing economic pressures may cause some firms to lower their client acceptance barriers, leading to working capital issues further down the line. 

“Partners are under enormous pressure to deliver fees. In many firms this is a measure used to assess performance and allocate profit share. This is fine, provided that it is linked to actually collecting the cash at the end,” he said. “When taking on new clients, there is too little focus on checking whether they will be able to pay once the work is done.” 

The CCW report says that firms should remind partners that failure to manage cashflow correctly could potentially result in deferred drawings and profit share payments. 

The survey, which covered both London and regional firms, also highlighted a continued depression of the legal market, with most participants only reporting small to modest growth. Those firms that did manage to prosper did so primarily through acquisition rather than organic growth.

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