Efficiency failures putting UK law firms at risk 

Flat profit margins and high lockup weakening financial stability, survey finds

Small to mid-sized UK law firms have enjoyed a year of sustained economic improvement, according to a new financial benchmarking report.

The survey found that, while fees and profits were up across the board, firms had failed convert these into higher profit margins.

“Improved revenue and profit levels are welcome, but profit margin overall remains flat, suggesting that improved efficiency was not a business focus in 2014, with many firms stretched and challenged to cope with increased instruction levels,” said Steve Arundale, head of professional services at NatWest and RBS, which produced the annual report.

“It is key that firms manage their business processes to become as efficient as possible in order to maintain or improve profitability. Firms need to be better at protecting themselves against the revenue peaks and troughs that are influenced by shifting economic conditions.”

The third annual survey received responses from 339 law firms from across the UK and with revenues below £35m.

Fees grew by five per cent on average in 2014, up from the three per cent growth recorded in 2013, equating to medium fees per equity partner of £473,000.

Median fees per fee earner were £138,000 – a notional increase of £2,000 on the previous year.

Profits increased by eight per cent on average, with the median profit per equity partner increasing by £20,000 year-on-year to £107,000.

London-based equity partners remained at the top of this group, earning £271,000 on average, up £25,000 year-on-year.

Scottish law firms achieved a five per cent increase in revenues in 2014, resulting in the first time in three years that they achieved an increase in profits.

However, equity partners in Scotland fared the worst in the UK in terms of earnings, taking home £84,000 on average.

Many firms failed to improve lockup in 2014. It increased by two days to 109 days on average. Smaller firms were typically better at managing this, recording a median lockup of 91 days, compared to 125 daysin medium-sized firms and 132 days in large firms.

Many firms are predicting a reduction in lockup days during 2015, although advisers to the legal sector do not share that optimism, suggesting that additional work can be undertaken to improve cash generation.

“The vast majority of legal firms fail to manage lock-up effectively, and consequently provide far too much credit to clients. This, in turn, can potentially generate cash flow problems,” the report notes.

A little over two-fifths of respondents said they anticipate improved work-in-progress days and debtor days.

The research found that firms are also failing to manage their overdrafts effectively. On average, spare capacity in overdrafts was at 11 per cent of annual fees, with little variance in this number among firms of different sizes.

This suggests that firms would run out of money in about 40 days if they received no further money from clients during that period.

“In order to preserve financial stability, legal firms must stay in touch with their cash position, and cash budgeting is more important than profit budgeting,” warned Arundale.The research found sustained optimism among law firms about their performance prospects for the next 12 months.

Four-fifths expect fee income to grow and 30 per cent expect revenue growth o reach 10 per cent or beyond.

In addition, 69 per cent believe profit levels will improve and 68 per cent believe chargeable hours will increase.

However, operational efficiency continues to be a challenge, with two-fifths of respondents expecting their profit margin to remain unchanged or to decrease.

Another challenge facing law firms in the coming year will be cyber security, according to the report.

Source: SolicitorsJournal – Efficiency failures putting UK law firms at risk

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