Top ten tips of sound financial management

Despite the almost daily stories of law firm failures, our experience is somewhat different and we continue to see signs of financial improvements in the law firms we advise.

In this article, I identify ten financial management tips for continued recovery in law firms in 2014.

1. Understand and manage capital funding.

Many firms carry inadequate capital account levels and often have a limited understanding of what drives the need for capital in their business. Firms that have a funding capital formula and owners who can differentiate between the elements of their profit share, that relates to a notional salary, as opposed to a return on capital, are ahead of the market in controlling their financial position.

2. Invest in cash-flow projections.

Most law firms produce financial projections, but spend little time on the cash-flow element of those projections which is crucial information to manage the firm.

In a law firm, the majority of cash flows can be assessed with remarkable certainty compared with many businesses. Even income cash collection can be reliably estimated with some statistical analysis and adjustment in assumptions from year to year.

3. Manage owner-drawing levels.

Profits don’t usually equate to cash. If profits are being generated ahead of cash, law firms need to review their drawings policy promptly and not wait until the end of the financial year.

4. Value unbilled time (work in progress) accurately.

Valuing unbilled time is about accurately monitoring profitability and about managing cash tied up in lock up. It’s not primarily about reducing or deferring income
tax liabilities.

Firms that run out of cash often fail to realise the extent of cash tied up in their lock up because the valuations included in their financial accounts are artificially repressed.

Remember, for cash management purposes, we are interested in cash tied up in unbilled time, not the value at charge-out rate or the value used in the year-end accounts.

5. Monitor earned income not just fees issued.

Management accounts of many law firms still often don’t properly monitor movements in unbilled time in a meaningful, appropriately valued, way.

Without such information, firms cannot reliably measure their profitability.

6. Monitor individual fee-earner performance.

Monitoring fee earner profitability by taking into account simple factors such as unbilled time movements, bad debts and claims costs are a powerful addition to really understanding an individual’s underlying profitability.

7. Share financial information with all owners.

In many firms, there is a tendency for a limited group of owners to receive regular financial information.

Predicated in part on the ‘fixed-share partner culture’, this has set a dangerous trend. It’s important that all partners are kept informed of financial performance and matters in
their business. Apart from anything else, under principle 8 of the 2011 SRA Handbook, one would argue it’s a pre-requisite under OFR.

8. Question whether strategic decisions really are strategic.

Mergers and trading structures remain high on topical lists for law firms. For some, these actions are truly strategic. However, there is propensity for firms to do these things because they feel comfortable going through the process. Lots of meetings and legal documents to keep people busy – but does it really make a difference to the business?

9. Be careful not to recruit too quickly.

After many years of total pessimism in the sector, we have been heartened to see genuine green shoots over the last year.

While it remains delightful to hear firms talk of the need to recruit, two words of caution. irstly, make sure your firm has sufficient capital to fund the additional lock up and, before you hire, make sure people really are busy. It’s been some time since your fee earners have had a really heavy case load to run – is the extra capacity needed yet?

10. Repair your balance sheet.

Many law firm balance sheets are weaker than in 2007. In a period of improving fortunes, there is a temptation for owners to take more profits out of the business.

Consider whether there needs to be some retention to restore the buffer that existed in 2007. Banks are open for business,
but they do ask law firms more questions than they did pre-2007. SJ

Andrew Allen is a partner and ?head of the legal sector at ?Francis Clark Chartered Accountants www.francisclark.co.uk. ?Contact Andrew.Allen@francisclark.co.uk