Larger mid-size firms are in danger of ‘overtrading’ as the economy recovers, placing them at risk of financial instability and even insolvency, figures for the past five years suggest.
Overtrading occurs when sales grow to a point where there is no longer enough cash left to pay creditors because receivables – money owed to the firm that cannot immediately be converted into cash – have grown too fast. That would include client fees for work in progress and litigation costs that can be recovered.
The figures, reflecting filed accounts for 6,500 law firms, were obtained by niche costs and pricing law firm Burcher Jennings. Overall, 29% of all firms reported in their most recently filed accounts that they had negative working capital. Martyn Jennings (pictured), chief executive of Burcher Jennings, said this was ‘worrying’.
When the firms were divided by size, the lower end of the mid-market showed rough parity between cash and receivables. For a fifth of firms – forming the upper end of the mid-market – receivables far outstripped cash.
If cash-at-bank increased by £25,000 over the five years, then the receivables balance increased by an average of £450,000. In this context, overtrading is the hidden risk of a more buoyant economy, Jennings said.
He told the Gazette: ‘With the opportunity of top-line growth comes the somewhat counter-cyclical threat of overtrading for any law firm expecting to benefit from a buoyant UK economy.’ As a result, Jennings added: ‘The worst may not be behind us. It may be immediately in front of us.’
Steve Din, former European head of restructuring at Citigroup, assisted with analysis of the figures. Din concluded: ‘A disproportionate element of working capital among these larger firms remains tied up in receivables.’
Filed accounts are ‘lagging’ rather than ‘leading’ indicators of financial health used by accountants, banks and regulators monitoring legal services businesses.