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Method in the madness of law firm finance


Albert Einstein, the famous theoretical physicist, is attributed to saying, “the definition of insanity is " doing the same thing over and over again and expecting different results" . Whilst there is no tangible evidence on record that Einstein said this, it is accepted the quote refers to human behaviour rather than simplifying a serious mental health condition.


Whether Einstein said this or not is one for others to debate however, regardless of its origins, the quote seems to perfectly address a problem with law firm finances.


What is the problem?

Many law firms have unusually high office balances!


Whilst that may sound like a good problem to have, in many instances, the high office account balances are masked by the various levels of support offered to law firms during the COVID-19 pandemic.


This point is reinforced by findings, in the Nat West Legal Report 2021 – a year like no other, which compares law firm performance for the pre and post pandemic period.


“Bank balances at the end of the 2020 period were substantially higher than at the end of the 2019 period. The median figure in 2020 was £542,000, compared with £63,000 in 2019
The Nat West Survey reports that at the end of 2020, the average law firm held 11% of annual fees, which equated to 2 months expenditure. “

Why is more cash held by firms?

Anecdotal evidence suggests higher cash balances are a result of a series of measure taken by law firm leaders. The top 5 include.


· unused (CBILS/BB Loan) borrowings retained to provide a valued cash buffer

· use of the VAT deferral scheme ‘smoothing’ interest free payments over time

· reduction in partners drawings/dividends

· reduced office running costs by staff working from home

· less business development /travel costs charged to the business


The above was further supported by government initiatives to support the wider economy, in which many law firms were able to utilise. The stamp duty holiday and the furlough scheme played a huge part in supporting the financial situation of many egal practices but as these schemes comes to an end and the repayment of borrowed funds begins, the future cash position will be on the minds of law firm leaders.


“Pre pandemic (2019) firms reported they held only c1.5% of annual fees. This may be a crude comparison however you can see why many law firms would struggle to deal with an interruption to business leading to reduced cashflow.”

Source Nat West Legal Report.


Removing the above factors, the Nat West Legal Report makes clear the median cash position, pre pandemic was c1.5% of annual fees. What this could mean is, should the behaviours surrounding law firm finances return to pre pandemic levels, many firms will struggle should the practice be impacted by another period of business interruption.


What should law firms do to improve?

The starting point is to follow Einstein’s advice and do something different which will drive different results.


To ensure long term survival, law firm leaders must consider what actions can be taken to maintain an improved cash position within the business. What steps can be taken to introduce sustainable, long term cash management techniques?


If we again reference the findings within the Nat West Legal Report, it could be argued the ‘old ways’ were ineffective. Too many firms had an overreliance on bank overdrafts and very little by way of business savings.


“We can’t solve problems by using the same type of thinking we used when we created them”.

Albert Einstein.


Reliance on management accounts will only ever provide a rear view of performance and in order to protect their investment in the firm, law firm leaders must look beyond the horizon to plan a better future.


How can this be achieved?

Positive actions taken now will support the firm’s ability to generate sufficient cash to allow the business to meet their ambitions, whatever they may be.


The Financial Stability Scorecard, offered by Gemstone Legal is the only one of its kind and can be an essential resource to provide law firms leaders with the opportunity to conduct a gap analysis in the financial control of the business.


“By developing new controls, the firm will encourage a new culture and encourage an improved approach to financial management.”

By completing 30 yes/no style multiple choice questions, the scorecard results will identify what a firm does well and where the business could improve its financial controls. The scorecard focuses on 3 important categories, which are.


· Financial Management

· Cash Management

· Borrowing


The Financial Stability Scorecard drills into the approach of these 3 categories and offers immediate results. Upon receipt of the results, should a firm require further support to map out the impactful actions to help the practice, a written report can be provided which is bespoke to the individual answers outlined within the scorecard.


A link can be found here: https://www.gemstonelegal.co.uk/financialstabilityscorecard


Conclusion

Referencing quotes from historical figures may help to deliver a message, however it can only be carefully planned actions that will deliver results. Financial planning can seem a daunting task, especially when the ‘to do list’ is a never-ending challenge advice would be the complete the Financial Stability Scorecard and use the results to plan your next step.


If help is needed engage a finance professional who will understand the actions required to improve performance and help to maintain higher cashflow levels in your practice.

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