The run-up to the Christmas holidays and the new year period can be challenging for law firms’ cashflow. Employees are typically paid earlier in the month in December and client billing slows, whilst Partner and Member tax payments are due in the new year.
Cashflow issues have historically been a significant contributory factor in law firm failures. As profits are distributed to partners, and it is more tax-efficient not to hold capital within the business, most law firms operate with a low level of cash, often using an overdraft as a buffer.
Law firms’ main costs centre on rent, salaries and PI insurance, all of which must be paid on a monthly, quarterly or annual basis.
Other liquidity challenges relate to the nature of legal work. Lock-up, the combination of unbilled work in progress and outstanding accounts, is a drain on working capital. According to various studies, law firms average between 110-140 days’ worth of earnings sitting in Lock-up.
It’s an issue that many law firms wrestle with and cashflow issues can impact smaller firms as they do not necessarily have the breadth of resources to call upon.
There are some simple steps that businesses can take to more effectively manage cashflow.
Plan, plan and plan again
Being fully aware of cashflow bumps in the road is the most effective way to mitigate and plan for issues. We advise clients to prepare a cashflow forecast for a minimum of 12 months ahead to assess where cashflow issues are likely to occur. We also advocate the use of a rolling three-month forecast for more accurate micro-management of cashflow.
Ensure adequate funding
Law firms have many funding options open to them to cover cashflow and other costs, such as overdrafts, bank loans and specialist legal sector funders, such as Iceberg.
One specific area to consider is the Quarterly VAT payments to HM Revenue & Customs. Meeting the cost of VAT each quarter, particularly when payment relates, in part, to unpaid fee notes can put a real strain on cashflow.
A VAT loan account is an option that enables the law firm to spread the cost over three monthly payments and retain the overdraft for genuine emergencies
Legal firms could also consider specialist financing for areas such as Partner Tax or Professional Indemnity Insurance.
Keep a close eye on lock-up
Billing discipline and hygiene is central to healthy cashflow management. It is recommended that firms bill on at least a monthly, or sometimes weekly, basis, where possible. Firms should also make sure they bill before the month end as this increases the chances of being included in an early pay-run.
By Mike Collins, Iceberg Head of Sales