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Financial Red Flags for Legal Firms and How to Overcome Them

Your firm needs to be on the front foot when it comes to identifying the warning signs of financial hardship - here are some red flags to look out for.

Financial Red Flags for Legal Firms and How to Overcome Them

A recent survey by the Solicitors Regulation Authority (SRA) found that over 10% of law firms (more than 1,200) are encountering financial difficulties. Commenting on the findings, Mike Haley, SRA director of supervision, said: “Sadly, some firms refuse to acknowledge that they are in financial trouble until it is too late, which causes problems for clients, and can also lead to investigations into conduct.” You should always be prepared for any warning signs that your firm might be entering rocky waters and react promptly, as the sooner you spot problems the quicker they can be dealt with and the less chance you’ll have of going under. Here are a few red flags to be on the lookout for and tips on solving or, preferably, avoiding them altogether.

Financial Red Flags for Legal Firms and How to Overcome Them

Departure of partners

Although there’s always bound to be a certain degree of staff turnover, if the most successful partners or key fee earners start leaving the firm this can often indicate an underlying dissatisfaction or perceived unfairness. Retaining talent is vital to your firm’s finances so you need to understand the reasons for resignations, particularly if a lawyer is transferring to a competitor. There is no single answer as to why employees decide to leave but there are some common themes such as inconsistency when it comes to reward and lack of faith in management.

Antiquated IT systems

Out of date computers and practices which don’t take advantage of modern technology such as managed hosting services will be losing out when compared to their more tech-savvy rivals. Aside from cost savings due to greater efficiency as a result of using the latest systems, firms with up-to-date IT and a forward-thinking approach to trends such as BYOD (Bring Your Own Device) will also be at an advantage when it comes to recruiting new talent.

Unaligned strategy

An agreed and unified strategy for the firm is important. If senior partners are pulling in a different direction to more junior fee earners this can lead to problems, particularly if clients notice any inconsistency in approaches. It’s crucial that the whole team ‘buys in’ to any change in direction in order for strategic planning to be effective and successful.

Excessive drawings

According to a survey, partner drawings exceeded profits in 20% of practices in 2013. If fewer instructions are being generated by clients and the practice is taking a financial hit, partners should consider reducing their drawings. If there is a failure to realign outgoings and, as a result, cash reserves become low and there is more reliance on overdraft facilities, this can lead to bigger problems down the line. Furthermore, there is a danger that non-partners will become unhappy with a perception that the whole team isn’t taking the strain, thereby moving their talents to fairer competitors.

Financial Red Flags for Legal Firms and How to Overcome Them

Delayed billing procedures

With certain clients, chasing up invoices may require a diplomatic approach. Although you don’t want to come across as demanding and money-grabbing, if you keep letting payments slide this will ultimately have an effect on your finances and can lead to serious problems. If you’re reliant on overdraft facilities, delays in collection of money owing to you is automatically pushing up expenses through interest charges. There are a variety of methods of chasing up invoices effectively and these should be used.

Trying to solve everything in-house

Sometimes it’s necessary to look outside the firm and take advantage of the professional experience of outsiders who may, for example, have more understanding about the ins and outs of optimising revenue and avoiding getting into financial difficulty or finding effective ways to deal with a cash flow problem. Getting an opinion from an impartial outsider can also give you some valuable perspective and allow you to see things with a fresh pair of eyes.

Pronounced capital investment

Unless the cash reserves of a firm are exceptionally high, any major capital investment in projects such as expansion into other service lines or territories can prove to be financially risky. These types of initiatives should be handled carefully and steadily; multiple expensive projects can indicate that a firm is trying to expand too quickly, often with disastrous results.

Get your free eGuide now: Balance sheet blues: How to cut costs when legal funding is under pressure.

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