Lock-up is not something firms can afford (literally) to stick their heads in the sand about, yet the number of firms struggling with lock-up (unbilled work in progress plus debtors excluding VAT) is staggering.
Crowe Clark Whitehill surveyed over 60 law firms recently, asking them to input data based on their recent annual results (normally to March or April 2011). The survey contained a good spread of firms in terms of size, with small firms to firms with a turnover of over £100m all well represented.
One of the most surprising findings of the survey related to lock-up days - one-third of firms had lock-up in excess of 150 days, and the average number of lock-up days amounted to 130 days.
Excessive lock-up can have detrimental effects. For example, firm X has an annual income of £10m and debtors and work in progress of £4.1m. Its lock-up currently stands at 150 days. In crude terms this means that it takes five months from doing the work for a client to converting it into cash. During that time staff and landlords have to be paid and partners will have wanted their drawings. If the firm was able to reduce its lock-up by 30 days, it would improve its cashflow by over £800,000.
The options firms have for funding lock-up are limited: they borrow from the bank, partners contribute more capital themselves or the firm restricts partners’ drawings or distributions. Under the SRA’s Accounts Rules, a law firm is not permitted to act as a bank for its clients by holding client money for no good purpose. By allowing lock-up to build, however, the firm is effectively extending borrowing facilities to its clients. Although not prohibited by regulations, it is risky for firms to extend so much credit to clients given today’s economic environment and high levels of corporate insolvency.
That same economic uncertainty, coupled with regulatory pressures on banks, means that a firm’s ability to agree terms with banks on renewed facilities or secure further loans is unlikely to get easier soon.
Firms can help reduce lock-up days by:
- Agreeing the amount to be billed ahead of time with clients
- Discussing interim billing options with clients
- Invoicing promptly upon concluding work (whether or not also billing on an interim basis)
- Employing consistency when it comes to credit control; partners must be on board, disciplined and timely to help improve cashflow
- Impressing upon fee earners/partners the importance of assuming responsibility for tackling lock-up and helping to collect bills. It’s best to maintain open relationships/discussions with clients about billing to ensure the process is a smooth one
Louis Baker (pictured) is head of professional practices group and Steve Gale is professional practices audit partner at Crowe Clark Whitehill