Making sense of the statistics describing the legal market at the moment is far from straightforward. The predictions coming from commentators and even the SRA suggest financial trouble at firms across the market will lead to failures and consolidation. On the other hand, the economy is growing and professional services even more so – with the legal, management and accounting sector up 7.5% year on year, and property transactions up by 23% on the previous year.
So it seems that different trends are affecting different sections of the market in different ways, with work types (and legal aid work in particular) having a disproportionate influence on some firms’ fortunes. It would also appear that stratification between the winners and losers within each segment is intensifying (which may have the perverse effect of improving the numbers by removing insolvent firms from the sample), which is entirely consistent with the patterns observed in other deregulated markets over the last 25 years.
Surviving the Upturn
However, one theme that firms of all sizes and profiles should note is that this can be a very dangerous time for businesses weakened by recession, as much of the legal sector undoubtedly has been. Economists and insolvency practitioners have demonstrated that in the last 100 years insolvencies have peaked in the early stages of the upturn in the business cycle. This is because businesses use up all their resources in surviving the downturn and do not have the funding available to grow back again. They are in effect “overtrading”. This is a particularly difficult issue in the legal sector because of the long lock-up periods to which firms have been accustomed, making growth in many legal disciplines ‘cash hungry’.
Significant commentators on the legal profession predict major disruption in the top 100 firms (see this report on Financial Stability by Baker Tilly, and PWC’s annual law firms survey (an email address must be provided to gain access to the report)). If these predictions prove to be correct then pressure on all other firms in the commercial sector is bound to intensify. Firms wanting to come out as winners in this competition will have to prioritise key business disciplines and get very good at the implementation. Our analysis of the top 20 attributes of winners in this market starts with the following:
- Financial Focus – on growth and retention, not extraction (American consultant Ed Reeser takes the view that financial problems largely stem from profit distribution – for a copy of his 9 point guide to retaining more profit, email email@example.com)
- Financial strength – which basically boils down to a solid balance sheet with low levels of debt
- Tight lockup – this is really the key to cash flow management in law firms, and most firms could take at least a month out of their lockup cycle
- Cost structure – flexibility and turning fixed costs into variable where possible are crucial
- Investment – the willingness and ability to invest in order to drive down staff costs and improve service.
Cash Flow Comes First
Before partners can think about how to exploit opportunities thrown up by market disruption they must, first and foremost, ensure the survival of their firm – and this means focusing before all else on cash flow and the balance sheet.
The second edition of our book, Cash Management for Law Firms, has just been submitted to the publishers. The focus is on the underlying issues such as the decisions partners take about the profile of the work and clients taken on, and the terms on which this is done, as much as on superficial issues like the competence of staff in dealing with recovery of debts.
We have seen signs in conversations with partners and their bank managers that firms are beginning to understand what is required, but the LMS financial benchmarking survey shows that 20% of firms have overdrawn profits for 2 years in succession – suggesting that perhaps Ed Reeser is right and profit extraction is the root of the financial problems in the legal profession.