The recession and continuing economic challenges highlight the increasing importance of law firms having an effective business strategy in place that considers the ambitions of the firm but ensures that those ambitions are delivered against access to suitable levels of cash flow. By Legal Futures Associate NatWest
Cash flow: management of it is a challenge in the legal sector
Profitability remains the most talked-about performance measure within the legal sector and carries significant value when considering the impact of cost management tactics or a business growth strategy.
In a business sector that continues to face income pressures, is increasingly cost conscious and faces additional cost associated with governance and compliance, it is essential that firms establish robust key performance indicators (KPIs) and monitor performance against these on a regular basis.
Banks are increasingly interested in assessing the fitness of legal firms against KPIs and against median benchmarks that look to assess performance across areas such as staff costs, property costs, profit to fee income, debt to fee income, assets to debt and debt-free capital.
By understanding and working with this data, banks are now in a position to understand how efficient firms are and work with them to understand how performance links with a firms immediate and longer term ambitions.
Robust and meaningful information
Good practice and financial management is key to the success of any businesses – no matter which sector you operate in; the legal sector is no different. It is imperative that firms have access to robust and meaningful information such as annual budgets, cash flow forecasts, profit and loss detail, rolling balance sheet and aged detail covering WIP and debtors.
It would be easy for firms to experience analysis paralysis against this volume of data and as such they should look to develop a dashboard analysis tool that all stakeholders can easily understand.
But, in isolation, financial information is of little value unless a firm truly understands what it is measuring performance against and that is why its KPIs must link directly with the business strategy, be that survival or growth. By setting KPIs in this way and measuring performance on a regular basis, it becomes easier for a firm to measure its distance and direction of travel. It also makes it easier to deliver a compelling argument if the firm is looking to its bank for additional financial support.
Our top tips when talking to your bank about your business strategy include:
Understand that cash is king – cash flow management is a challenge in the legal sector because of the ability to convert work in progress and debtors into cash. By doing this, you can manage your bank’s expectations and discuss with them when you need additional funding. Banks are a good source of help for guidance when undertaking cash flow forecasting and business plans.
If you have detailed and strong systems and business plans, it will allow you to act on warning signs before they become a problem and is also vitally important to demonstrate the strength of your firm to your bank when seeking financial assistance.
Look at your ratios – effective business planning and understanding your cost ratios is vitally important in a tough economic environment. The fundamental questions to ask yourself are ‘Are we making money?’, ‘Are we generating cash?’ and ‘Do we know where we are going?’
Question leverage levels – increased borrowings may be the easy option but is it the right option? Generally, banks remain active supporters of the legal sector and regular providers of new and increased funding. But firms should appreciate that banks are now looking at total gearing levels across trading activities and capital accounts and they expect equity partners to demonstrate commitment and responsibility to the firm by supporting its cash requirements against a fair and reasonable level of personal investment.
The opportunity for partners to restore overdrawn current accounts by simply injecting more personally borrowed cash will become more challenging and banks will expect partners to have ‘skin in the game’.
Quite often the need for additional capital doesn’t exist and with some added focus around the management of lock-up (a ratio calculated as debtor level plus work in progress divided by revenue), cash can be released against marginal business stress and mitigating the need for additional cash calls on the partners.
Review the funding options available
We are committed to ensuring customers benefit from a wide range of initiatives and can offer a suite of bespoke financial solutions tailored to suit your requirements. Matching resources with customer locations, we have teams of specialist managers around England and Wales.
Specialisation gives our team more time to dedicate to customers and understand their needs. We understand that regional firms and city based ones operate differently. We work closely with you to understand the issues affecting your firm, to understand your ambitions and will deliver the right solutions to fit your individual needs.
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