Feature

posted 4 Jun 2008 in Volume 11 Issue 2

Masterclass: Back to basics

A 10-point plan to becoming a more financially-successful firm

By Peter Scott

Financial performance needs to be seen as just the ‘tip of the iceberg’, in that it is generally a good reflection of everything that is going on in a firm below the waterline. Deal with those underlying issues, and better financial performance is likely to follow.

But financial management is itself one of those fundamentals that firms need to get into shape, and because it sits alongside a number of other problem areas to be addressed, bringing good financial disciplines to bear on a firm will inevitably come up against reactionary and complacent attitudes on the part of those who do not wish to, or cannot see, the need to adapt to change. Of course, good financial management cannot ‘deliver the goods’ alone if those other fundamentals are not first dealt with.

A major benefit to be derived from just carrying out the exercise of trying to put in place good financial disciplines can be to identify and highlight where the real problems exist in a firm, and for management then to tackle them – if it has the will, skills and internal support to do so.

In reality, these two processes – driving basic financial disciplines and overcoming the internal hurdles to change – need to go hand in hand if firms are to adapt to the changing needs of clients and successfully meet the challenges of the future.

Below are ten basic ‘things to do’, which have not really changed over the years, as, while the challenges may increase, many of the solutions remain the same.

Get your partners into shape

As a starting point, if progress is to be made in financial performance, firms need to adopt a positive and open-minded approach, learning from the ways other, perhaps more successful, firms do things, rather than continuing to operate as they have always done, or instead of always accepting that there is a reason why something cannot be done, in other words saying ‘yes, but…..’. This issue alone will bring many of the underlying hurdles to change to the surface – those that may be preventing firms from making a great deal more of themselves financially. They should ask the crucial question ‘Are our partners prepared to be managed?’ If this is an issue, unless a firm is prepared to deal with it, very little progress – if any – is likely to be made.

Provide sufficient resource

It may not be palatable to some partners to see ever-more so-called ‘non fee-earning admin staff’ being taken on, but it can be a serious mistake to starve a finance department of essential and good-quality staff.

Firms need to analyse what they are going to require in terms of people resource if financial management is to be taken up a few notches, and then set about putting that resource to work. For example, they should ask:

What do we need from our financial director?
Do we need to replace our credit controllers with revenue managers to take control of the management of both work in progress and debtors?
Should we employ receivables managers to drive credit control?

Paying to have well-trained professional financial staff on board is likely to make far more economic sense than having a partner simply ‘play at’ being a finance partner, which is common in many firms. Instead, employ an FD that understands what needs to be done to get the firm into good financial shape, and who can command sufficient trust and respect from partners to enable him or her to get the job done.

Analyse your business

If decisions are to be made regarding the future of a firm, they should be based on known facts alone, and not on perceptions.

Analysis of every part of a firm is needed before any decisions are made or actions taken. For example:

Do we know the true profits/losses being made by each part of our firm?
Will this part of the firm ever be capable of being profitable?
How profitable/loss making are some of our clients?
Do we know which parts of our firm soak up cash at an alarming rate?
How much working capital do we really need in this firm?
If a firm doesn’t have an FD capable of analysing the financial performance of a firm in such
terms and then finding solutions, that firm needs to get a new, (and better!) FD quickly.

Financial reporting (or how to avoid financial information overload)

The purpose of financial reports should be to provide clear information to those running the business – to enable them to know what is happening and to indicate
what actions need to be taken for maximising financial efficiency and the wellbeing of the firm.

However, all too frequently I see firms producing financial reports that achieve very little of the above, often with the result that the reports just get binned.

If firms can use their financial analysis of the business to identify the key performance indicators (KPIs) they will need if they are to manage the finances of the firm
most effectively, and then translate this into clear and understandable reports, preferably using graphs where appropriate and ideally on just one page, then this is likely to be a huge step forwards.

Firms should test the state of their existing financial information by asking questions such as:

Why do we need this information?
Do we ever use this information?
What information do we not produce, the lack of which is preventing us from effectively driving financial performance?

Take control of cash management

As always, cash is king. Many partners in firms probably have far too much capital (fixed and current accounts) tied up in their firms, which would not be required if cash management were being driven as it should be.

Firms need to calculate their minimum working capital requirement (in other words the minimum amount needed to finance ‘best practice levels’ of work in progress, debtors and unbilled disbursements, given the nature of their business and plans for future development) and that should be the target to achieve. Firms can test their working capital management by asking questions such as:

How quickly are we able to pay out profits to partners from last year?
Are we able to repay capital to partners when they retire?
What is our debt/equity ratio?
Is a cash call on partners likely to be required shortly? If it is, then alarm bells should ring.

Again, analysis of every part of a firm will reveal where the cash blockages exist, and where some hard decisions may need to be made. Given that the ultimate purpose of cash management is to generate cash, firms should consider taking control of the process and implementing cash-generation plans built around cash-collection targets for groups/partners, arrived at based on levels of aged work in progress and aged debtors, and which are linked to payments of drawings/profits to partners. This will begin to test ‘how hungry’ the partners are.

Building profitability as a strategic aim

Turn your strategic-planning process on its head and consider objectives such as:

‘Over the next three years we are going to achieve profits per equity partner (PEP) of:

Year 1 £[ ]K;
Year 2 £[ ]K;
Year 3 £[ ]K.

…and every decision we make will be considered and judged in the light of how and whether it assists/detracts from achieving these objectives.’

This bottom-line-driven approach to strategic planning will bring into clear financial perspective the plans of each part of the firm, and can provide a much needed financial benchmark for testing strategic initiatives.

Control overheads

If overheads are under control and cannot be reduced, then greater profitability can only come from building greater revenue.

However, to what extent are overheads in firms really under control, in the sense that firms are ‘running lean’?

Firms need to look at every individual item of overhead (and particularly their people overhead, which is usually by far the single largest item) and ask questions such as:

Is this overhead necessary for the efficient and profitable operation of our firm, or could we do without it/use it less?
We know we must have this overhead, but how can we reduce the cost of providing it?

I suspect many firms would be surprised to discover just how much unnecessary ‘fat’ they are carrying. A regular testing of every item of overhead, and the price being paid for it, has to be one of the most basic financial disciplines required to run a profitable firm – and it isn’t difficult to do.

Price your work for profit

Pricing is often forgotten about as a fundamental driver of profitability.

Pricing needs to be controlled at the very outset of each matter, as well as controlling discounting on billing and collection. My observations tend to indicate that work in many firms is taken on at prices that cannot make money (or worse, can only lose money). Some firms seem to have no effective controls on partners taking on work at prices that bear no relation to the need to make a healthy profit margin, to the marketplace, or to the firm’s cost base. Work is taken on just to stay busy, without regard to the financial consequences. This issue ties in very closely with a recognition of the importance of recording of chargeable time as a management tool, indicating how much a job can cost to get done. Unless a firm knows that, how can it quote a price for the job?

I am not convinced all firms have properly analysed their marketplaces to know what the real market rates are (both headline and recovered) for particular types of work. The methodology adopted to arrive at revenue budgets, often employing ‘tariff rates’, adds to the artificiality of the exercise, and gives partners the idea that they can freely discount ‘because it is only a tariff rate and not real’. If jobs are lost which, if taken on, would have lost money, then so be it.

Who should decide?

Firms need to lay down pricing parameters, within which partners are allowed the freedom to operate. Outside of those parameters they should obtain the approval of management. Certainly, in the case of large matters, the approval of a managing partner or a group of partners should be sought, not only for pricing purposes but also in relation to risk.

Capturing time

Chargeable time should only be regarded as one component in arriving at what is the ‘right price’ for a job. It is, however, an important component, because without recorded chargeable time and accompanying descriptions of work carried out, firms may have very little evidence of what work has been done on a matter.

Too many lawyers try to say that time recording is irrelevant to their particular work. Recording chargeable hours is a management tool, and as such ut is relevant to every part of a firm, but this message is lost on many firms. For example:

How can we have a realistic budget, based on a certain number of chargeable hours being recorded per annum by each fee-earner, when large parts of the firm do not fully time record?
How can we see whether we are ‘on budget’ as far as input is concerned on a weekly/monthly basis?
How can we tell whether all our people are busy/overworked?
How can we plan billing and cash flow effectively if we don’t have honest and accurate work in progress figures?

Here are a few suggestions that may help:

Put in place daily chargeable hours targets for all fee-earners, based upon their budgeted hours, which are then closely monitored on a weekly basis and followed by discussions with every fee-earner who falls short of target;
Get rid of non-chargeable codes other than for those who have genuine non-chargeable tasks to carry out. Non-chargeable codes are a dustbin – if removed people have nowhere to hide!
Have an automatic e-mail appear every morning as fee-earners log on asking them if they have fully recorded their time from the previous day.

Improving the recovery rate

The factor that can have the greatest impact on profitability is improving the rate of recovering work in progress on billing. However, a firm will not be able to calculate its recovery rate unless there has been a full capture of time.

To see the potential impact this can have on profitability, a firm should ask itself what a ten per cent improvement in its recovery rate would mean for the bottom line.

As a means of improving the recovery rate, firms should put in place an effective write-off policy. For example, no writing off of work in progress outside of certain parameters should be made without the managing partner’s (or equivalent’s) written approval.

Trying to deal with the above on a piecemeal basis is unlikely to be as effective as putting in place a prioritised plan to get to grips with those issues impacting on financial performance that are going to make the greatest difference.

So instead of feeling the squeeze, put the squeeze on your business!

Peter Scott is a solicitor, and was formerly managing partner of the London and European offices of Eversheds. He can be contacted at pscott@peterscottconsult.co.uk