Back to Basics for Lawyers: Finance and Financial Management
Welcome to the February edition of Back to Basics — a Business Briefing for Lawyers. In this edition I focus on Finance and Financial Management — an absolutely crucial area that every fee earner needs to be involved in.
Financial management starts from a simple premise — if you can win and keep clients profitably then you will succeed. The question is how do you assess the profit?
Consider what reports you need to work with every month—and how to analyse these. Think about looking forward and doing some predictive calculations to show you how you can manage financial projections over the course of your financial year.
John McNeill, Business Restructuring Director at BDO LLP considers the premise “Cash is King” – and it is! Without positive cashflow every business will struggle to survive, never mind progress. Rendering Fees is one thing — recovery of fees is an essential part of every fee earner’s duties.
It’s not about the money…..or is it?
There’s an old adage that says “It’s not about the money….” but, at the end of the day, it almost always is! It is true that if you win and retain clients in a cost effective way — that means that you make a profit out of every bit of business you do for a client — then the money will take care of itself, but it’s nice to be sure. This means that you need to check your financial performance on a regular basis.
It is simply not good enough to look at your Bank balance every so often — it might be good — or, on the other hand, in times of a downturn it might be very bad indeed. There is a range of reports that you should consider at least once a month. These include monthly Profit & Loss Reports, Fees Rendered and Recovered Reports (by fee earner, if possible), Outlays and Expenses Report (if your system provides you with one), Client Credit Balances over £500 (although it’s better to run this Report every week) and client Debit Balance Reports. If your Practice Management system provides it, you should look at an Aged Fees Report — and then you can consider what Credit Control steps the firm needs to take to manage this position. Get into the habit of looking at the figures monthly and speaking with your fellow fee earners about their performance.
On an annual basis, review your results and compare them to results in previous years using a range of Ratio Analyses—this will allow you to compare performance without having to try to compare actual figures. This will also tell you if your are performing better or worse than in previous years. Consider your Net Profit Percentage – how much of every £1.00 you generate in revenue do you get to keep?
What about your Debtor Days Ratio — are clients taking longer to pay you than they’ve done in previous years? What percentage of Revenue is your total Salary Bill – and is it a higher or lower percentage than previous years? These measurement will give you some clues as to the firm’s financial fitness.
It’s all very well reviewing your figures after the event, but “how can I manage forward”? This is a question I’m frequently asked by clients. My answer is always, set a budget for the full year, lay it out on a month to month basis and then overwrite the figures with the actual results each month. When you do that you will find that over the course of the financial year, as the actual figures replace your projected figures you will be able to gain an insight into how your firm is likely to perform by the end of your financial year.
The first stage in the process is to set a budget. For whatever reasons best known to themselves, many firms don’t normally set revenue and expenditure budgets. As a result, they have no real basis to determine their performance. You will need to use a spreadsheet for this. It’s a simple and straightforward task to prepare a set of Revenue and Expenditure Projections. Set out the spreadsheet showing the Revenue and Expenditure Items in the left hand column and along the top of the spreadsheet put the months—starting from the first month of your new Financial Year. Think carefully about what the firm is likely to generate by way of Revenue and what it is likely to spend on each item in the coming year — and in a worst case scenario, take the total of each Revenue and Expenditure from the previous financial year, divide it by 12 and then put that figure in each of the months over the year — Revenue at the top of the columns and Expenditure below it. Then add up your different revenue streams and deduct the total expenditure. This will give you your net profit or loss each month. You should also show a column for Totals at the right hand side of the spreadsheet so you can add up each row and that will show you your annual totals for each Revenue and Expenditure item.
At the end of each month, overwrite the figures for that month with your actual figures. If the spreadsheet is structured properly, it will recalculate your figures for the year.
By building in a few additional pages to your spreadsheet you can extend its functionality and look at revenue per fee earner, fee earner averaging and revenue comparisons (where you can set your budgeted figures for the month against the actual result for the month). This means that you can see on a consistent basis which areas of the firm are generating more or less than you had projected. From an expenditure perspective, you can again carry out a comparison against your budget and very quickly you will see any items where there has been an overspend or an underspend. This gives you a “heads up” on something that might be going on that you had not expected or budgeted for – and at least gives you a chance to do something about it before it gets out of hand!
There is no magic in the numbers, but if you use a tool like this you will give yourself a chance to head off problems at the pass — or in the case of revenue, work out why fees in certain areas are not performing as you predicted and do something about it — and where certain work types are performing better than expected, work out why that is and THEN DO MORE OF IT.
As Brian has noted this month the role of the Partner is a multi-faceted one. Obviously a good legal analyst is the result of training and education – that prepares you for being a lawyer. Then, when you make Associate, you are expected to be able to generate your own clients and revenues and then, when you make Partner, you are expected to contribute to potentially all the senior roles – Staff Partner, Client Relations, MLRO and the “dreaded” Cash Room Partner (or as I heard it described recently as ‘The short straw’). The role of Cash Room Partner can be daunting as it does deal with quite a lot of different things – Law Society inspection, HMRC, VAT returns, PAYE & NIC, cashflow, surplus, accounts, budgets, etc, etc are aspects that Cash Room Partners need to keep under control whilst often being expected to keep up a full-time fee earning role as well. A good cashier is helpful and I know many a Cash Room Partners who operate with a high degree of delegation in this regard— which is fine — but you cannot delegate accountability. Everyone knows where the buck stops.
So, take some time to become conversant with all of the aspects, not in-depth, but a knowledge of the parameters and understanding of the meaning in the numbers. I suggest that if you are not in the habit of ‘presenting’ the management accounts to your Partner colleagues each month , then do that. This is an excellent way of learning on the job. It will also help your colleagues to raise issues and ask questions. Time and again the Clients Trial Balance report, Outstanding Fees report and Bank Statement get circulated each month. Everyone looks at the last couple of pages and because they don’t understand them, simply pass them on. These same firms look forward to the Accountant’s annual report approximately 6 months after the financial year end to see if they made any money by which time it’s far too late to do anything about it! No, nowadays whilst Cash is King in terms of month to month sustainability, it is vital that some effort is made within the firm to understand the current trading position. Take steps to ensure that there are no nasty surprises at Financial Year End because everyone who should know what the position is does know, every month, and are helped by their colleagues to understand and improve this where possible. It’s no use to a older Partner that there is no money in the firm. It’s no use to a younger Partner that there is no money in the firm. It is vital to all that there is demonstrable viability in the firm at all times – and all Partners need to work together to achieve this to the best level possible and keep it there.
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Cash is King!
As we see some very early signs of green shoots of recovery you may think that an improvement of the economy is just round the corner. However, this does not disguise the fact that what has become the most important factor in running any type of business today is cash flow management. We have all read the horror stories in the press recently of the effect that the adverse weather in December had on many a business cash flow. The sectors that have been particularly badly hit include retail and leisure & hospitality, both of which rely heavily on consumer spending. You can imagine the effect if you have budgeted for a certain amount of income and you are hit by a sudden shortfall in revenue. In days gone by when your local bank manager perhaps had the ability to grant a short term overdraft to tide you over, nowadays that is not so likely to happen. However, you should keep your bank in the loop as they are more likely to respond favourably if you keep them informed. As a rule, your bank does not like surprises!
If you are experiencing cash flow difficulties and are unable to pay your ongoing liability to HMRC in respect of VAT & PAYE then you should approach them to enquire about a time to pay order.They will normally give you a fair hearing and, as long as your proposals are acceptable to them, they could go with it. However, a word of warning. If you default in any arrangement that you have negotiated with them, it is normally all bets off. You should always bear in mind that HMRC have to be paid sometime. In a non cash transaction business where credit is given to customers, collection of cash is of paramount importance. If you operate your own credit management system it is important from the outset to ensure you are dealing with the correct entity and also set realistic monthly credit amounts for customers. Try and spot any potential bad debts before they happen and gather as much data and knowledge about your customers. Of course, many owner operated businesses have difficulty in credit management and more medium to small businesses are turning to Invoice Discounting or Factoring. This is where the firm invoices its customer and the factoring company immediately pay you an advance of up to 75% of the sales value and the balance when collected. This can ease your cash flow position but it can be expensive especially where a bad debt is suffered and the funds already advanced by the factoring company have to be repaid to them. Again, the golden rule is to try and avoid bad debts. This short article only gives you a flavour of the subject and I would be happy to discuss this topic further if you or any of your clients have any specific issues.
John McNeill is the Business Restructuring Director, BDO LLP and can be contacted at 4 Atlantic Quay, 70 York Street, Glasgow G2 8JX, tel: 0141 249 8409, mobile: 07896 114 904, email: firstname.lastname@example.org
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Brian O’Neill LL.B MBA, Business Consultant, t. 01294 833220, m. 07855 838395, e. firstname.lastname@example.org