FINANCIAL GOVERNANCE AND BEST PRACTICE KEY TO RISK LIMITATION IN LAW FIRMS

By Andy Sparkes, General Manager, LexisNexis Enterprise Solutions, a provider of business management systems to law firms

Time and again we hear of law firms in financial difficulty. On last count at the end of 2013, the Solicitors Regulation Authority (SRA) identified over 1200 firms.  Most recently, the SRA has found that there is a direct correlation between financial difficulty and misuse of client monies, substantially increasing risks to customers.

This comes as no surprise. In all likelihood, the mismanagement of funds is inadvertent. Today, many law firms face financial problems of a similar nature – be they due to regulations, competition, economy or other. What sets firms apart is how they deal with the tough operating conditions – those that are able to manage the situation through good governance and best practice are better placed to reduce the risks and limit impact.  A lot of financial issues emanate from lack of control and visibility of business vitals.

Historically, law firms were cash rich and any funding requirements were dealt with by partners. So, the level of effort put in to manage the lockup lifecycle – i.e  time between the start of recording work and eventual payment of the client invoice – was minimal. Lack of timely invoicing and collection procedures makes visibility of cashflow a problem, in turn making cash flow forecasting an even bigger issue. For instance, CFOs find it harder to arrange financing. Also, law firms run the risk of being charged punitive borrowing rates on inadvertent overdrafts. Embedding processes that ensure timely invoicing provide real-time visibility of client matters, instant information on upcoming liabilities and incoming cash are therefore critical.

This has a major bearing on procurement too. Without a view of the firm’s liabilities, often finance heads don’t know about the goods and services that have been purchased by the firm. This results in client invoices not including such costs, which can be disputed by customers if invoiced later. This then directly impacts the firm’s profitability. Centralising procurement processes is a must – right from raising a purchase requisition to accounts payable. This becomes even more critical for multi-jurisdictional firms.

For many law firms, budgeting is a tedious and manual process. Perhaps that is why often budgets tend to be set annually and not revisited until the next cycle. Budgeting is not a static function; there are many variables that affect a budget. Without the right tools and processes, modelling variances in the budget is an extremely time consuming exercise. Budgeting needs to be an ongoing process and its value is in it being used as a tool for financial planning and performance monitoring. For instance, if collections are not adhering to projections, it is a cue to CFOs to investigate the discrepancy. Is it due to an issue with the invoicing  cycle, are fee earners  not accurately recording time or is it simply that business is low? Similarly, budgeting must be used to control over-spend and liabilities. In almost all industries, budgeting is automated. It ensures that budgeting is an interactive process that is in tune with changing business needs. In addition, automation makes certain that the latest processes and principles are used.

Alternative fee arrangement is another challenge that many firms are grappling with. Clients are demanding all types of alternative fee arrangements and deep discounts including conditional fees, fixed fees, capped fees and blended/combination rates. Law firms  must charge fees that are  accurately based on expected duration of tasks, level of personnel best suited to matters (i.e. partner, associate, para-legal, etc.), combination of fee models to maximise budgets, discounts offered, outsourcing costs;  and so on. Firms don’t routinely undertake cost and profitability analysis, or business forecasting. Aligning fee structures with the revenue and profitability goals of the organisation is necessary.  Adopting processes that provide transparent, timely and clear reporting on the firm’s health metrics is imperative. This allows informed decisions to be made for the benefit of the business and its customers.

Given the current economic constraints that both clients and legal services providers face, law firms need to explore all avenues for securing new business. A collaborative, multi-practice approach to client service drives short terms gains as a means of driving up revenues. In most firms, the technology systems deployed don’t support multi-disciplinary, multi-department and multi-region working. There are variances in cultural practices, fee structures, regulation and compliance and even remuneration. A collaborative way of requires end-to-end, fully-integrated, cross-department processes that offer visibility of matters that the firm is working on. The firm must have the capability to invoice the client for multiple matters from different parts of the business in one single invoice. Employees also need to be able to work seamlessly on shared files so that the organisation can successfully pitch for and manage higher value business to drive profitability.

Today, many CFOs and financial directors in UK law firms are under pressure to also take on the role of COFA (compliance officer for finance and administration), a position introduced by the SRA in January 2013. It is an attempt to make the appointed COFA personally responsible for reporting accounting rules breaches to the SRA. Firms manage compliance through specifically designed applications to handle SRA accounting rules, but these systems are niche. Their functionality doesn’t extend to industry-wide business practices, greatly increasing the risk of breach. Having automated processes that address accounting rules locally, but also provision for multi-jurisdictional conventions for cash management, collection, expenses, conflict checking, money laundering and the like is necessary.

Essentially, what I’m saying is that the modern law firm needs to institute non-legal, industry-recognised best practice processes for financial management and regulatory compliance. As mainstream business entities, they must adopt processes that adhere to the wider corporate norms. Experience of other sectors is evidence that utilising enterprise resource planning-style business management systems for financial management is a reliable approach. Today, there are such systems that have been specifically tailored for the legal sector, based on Microsoft technology. Collas Crill, the Channel Islands law firm, is an example of a legal services provider who has gone down this route earlier this year. Russ Newton, Finance Director at Collas Crill recently commented, “Already we can see the benefits of this single business management system approach and are more convinced than ever that this investment has positioned us well for the future.”

Such systems offer integrated capabilities to facilitate business efficiency and cost control. At the same time, they deliver flexibility and agility to law firms to meet revenue targets and ensure a healthy bottom line. They must be a serious consideration for law firms.