LEGAL services have long been seen as one of the safer bets in an ever-changing economic climate.
The world will always need lawyers to assist with everything from writing wills and house purchases, to large corporate transactions. But in an increasingly complex financial and tax regulatory environment legal firms are not immune to financial difficulties.
Effective law firm management is becoming increasingly more complex, which is highlighted through recent high-profile failures nationally and north of the Border.
Unfortunately, a number of established Scottish names have disappeared. Most recently there have been Pagan Osborne and Tods Murray, but several others have gone before them and unless some legal firms change how they operate there is a risk that more will follow.
Why these businesses have failed is simple. In the race for growth of turnover, firms have focused on the war for talent, prestigious offices and increasing demands in terms of regulation and compliance, and insufficient attention has been paid to their cash position.
It is no longer enough for the partners of a law firm to be technical experts in their chosen disciplines, they must also understand how to run a multi-faceted business.
This step-up is almost expected, which seems unreasonable – nobody would assume someone who was not legally trained should consider the nuances of a contract so why should there be an expectation of excellence in fields such as finance for legal partners? This skills gap could be, inadvertently, leading to financial difficulties.
Despite a very simple business model in comparison to many businesses, law firms’ financials do present a number of challenges.
Take profit earned based on fees issued, for example. This is all very well but until it is collected how can it be distributed to staff and partners?
In a fast-moving market, there is a constant need for investment in infrastructure, such as IT, and this all requires expenditure prior to repayment of that investment.
Without knowing the accurate working capital position, how can law firms plan for future requirements?
In addition, how long does it take from an initial meeting or instruction for a fee to be raised and, even more importantly, collected?
These timings should be easy to measure across all parts of a law firm, but this is often not the case, or at least not until there is a problem.
There also needs to be real scrutiny of the actual value in certain work done and fees issued, as carrying balances with little or no value can very quickly distort the profitability picture. There is a danger that payments are being made based on inaccurate expectations of cash balances.
If a firm is operating with a tight cashflow there are some easy options to assist, such as reviewing the timing of partner drawings, VAT quarters and loan repayments, and genuinely looking at how to best manage cashflow.
These arrangements are often historic, but some simple planning can dramatically improve the cash position.
Added pressure comes from changes with banking relationships as more scrutiny is now applied to funding applications. While a strong in-house finance team can be more than capable of doing all that is required, there is no doubt that an independent eye on the finance function and practices is invaluable.
It is much better for a firm to seek help before a concerned lender, with a potentially different agenda, instructs its own external review.
Detailed financial models and management information are essential for the modern law practice and without these the risk is that cashflow difficulties can creep up quickly on firms.
Without this foundation on which to make decisions it is very difficult to see the effect that relatively small changes in the business may have on the cash position and it is also impossible to truly plan for the future in terms of staff numbers, partner capital requirements and the ability to trade at the right levels.
In a competitive market the problem can grow very quickly and put firms in real jeopardy. However, on a more positive note, the opportunities for well-managed, high quality professional service firms in Scotland remain fantastic as the need for advice has never wavered.
That said, unless firms take care of their cash position the chance to capitalise on these opportunities will not materialise.
Alex Tait is an audit partner at RSM.