For many years, the legal profession has been subject to the apparently small but persistent problem of managing lock-up. Firms consistently have large outstanding debtor days and poor cash flow. In normal times, this leaves firms with limited cash resources to invest in the business. Today, as law firms struggle with the impact of COVID-19, it may pose a more serious threat.
In reviewing the accounts of the top 50 law firms for 2018/2019, the good news is that debtor days have fallen by 1.4%, an improvement on the increase of 0.3% seen in the previous year. Cash levels have increased by 14.6% and, on average, firms hold £30.4m of cash at the year-end. At the same time, bank loans and overdrafts have fallen by 10.4% to an average of £16.4m.
As such, law firms have improved their preservation of cash and paid down debt. However, these are marginal improvements: debtor days still stand at 119 days, equivalent to £5.8bn at law firms’ year-end in unpaid invoices. Unbilled work in progress is still a problem, increasing by 9.9% this year, following an increase of 11.5% the previous year.
Firms’ cash position, in aggregate, looks precarious. The net cash position of the top 50 law firms is just shy of £700m at their year-end, compared to the monthly wage bill of around £650m. A relatively small shock could see law firms struggling to pay their staff.
The Coronavirus pandemic is proving far more than a small shock, with demand for legal services highly unpredictable. With government support schemes, most firms should be able to keep going for a few more months. However, many firms have been wary of taking government cash, fearing reputational damage or restrictions on partner payouts further down the line.
We believe the crunch point for many firms may come in late this autumn, when the reality hits regarding the size of the partner tax payments that need to be made in January 2021. This may be the point at which many firms realise they don’t have sufficient cash to meet this obligation.
Equally, aggregate figures mask the strong position of some firms and the far weaker position of others. Clearly, those firms more reliant upon debt may find they are in a more precarious position if cash flow weakens.
If there is one silver lining from the pandemic, it may be that firms become tighter on credit control. We initially thought Brexit might be the shock that would galvanise law firms into taking action but the impact of lockdown has the potential to be far larger and more destructive.
Of course, tackling lock-up would deliver vast resources to law firms that could be used to invest in technology and personnel, shoring up their business for any tough road ahead. To our mind, it would be worth the effort.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.