Managing Lock Up - By SPONSOR PKF Francis Clark LLP

Managing Lock Up - By SPONSOR PKF Francis Clark LLP

FINANCIAL MANAGEMENT - MANAGING LOCK UP

 

Lock up within a law firm is an essential area in which a practice needs to maintain control to assist in generating cash resources and as part of maintaining their overall financial stability requirements.

 

What is lock up?

 

Lock up represents a working capital requirement in a law firm. This is derived from both office balances outstanding and unbilled amounts of time recorded in undertaking a matter to be charged to clients. In essence these are assets / resources due to the practice which will potentially be converted to cash over a period of time.

 

Office balances outstanding include amounts billed to your clients for fees and disbursements but also for disbursements in which the practice has funded but remain unbilled and not settled from funds held on account in the interim

Unbilled time is often referred to as accrued income or work in progress (WIP) and for lock up purposes should reflect the time recorded at the fee earner’s full charge out rate.

 

Why is managing lock up important?

 

In simplistic terms to demonstrate how lock up affects cash resources; a practice will undertake a matter where it may not be possible to bill the client for a lengthy period of time. Over this time frame the law firm will be incurring various related operating costs which are in turn being reflected in the underlying unbilled time generated as the matter progresses.

 

The operating costs need to be financed from the practice over the course of the matter but no cash is actually received from the client until the unbilled time is converted to a bill of cost and settled. Hence there is a time frame where outgoing cash exceeds incoming cash.

 

Multiply this scenario by several hundreds of matters and the absolute level of the interim cash requirement can soon become a significant amount. To finance this requirement, funding needs to be obtained which can be from sources such as a bank loan or overdraft and from the business owners’ personal cash resources which would be introduced into the business as capital.

 

Whilst banks may look to provide an element of funding towards working capital requirements this will only be up to a certain limit and it is the principals of a law firm that are required to provide the majority of this cash requirement.

Where lock up can be efficiently managed, the cash call from the principals own resources and the bank / financing costs can also be kept at a minimum which can be a strong incentive.

 

The extent of the cash needed from lock up will vary from practice to practice dependent on size, structure, work types undertaken and its internal policies and procedures, which are where the firm’s COFA can play an important role.

 

How can firms manage and improve lock up?

 

Initially to measure how efficient the firm is in managing lock up, key performance indicators (KPIs) can be used. The main ones are debtor days and WIP days which can be benchmarked against industry data. High results of these KPIs can indicate a potential issue within lock up which needs to be addressed.

 

In terms of the ongoing management of lock up there are a number of routine areas that firms can review, introduce or improve internal policies. The extent of policies and procedures adopted will of course vary dependent on the size of practice, work types undertaken etc., however example areas which can be considered are shown below.

 

Unbilled Time

  • An important starting point is to ensure a firm and its fee earners can, and do, record their time promptly. Clearly being able to manage lock up within unbilled time can only be effective if it is appropriately recorded in the first instance.

  • Certain time recording systems can produce exception reports to show which fee earners do not regularly keep their time recording up to date, and this can be addressed accordingly.

  • Where a tendency arises in firms not to time record for fixed fees it should be emphasised this is still vitally important, not only for managing underlying lock up to assess the cash resource requirement but also in assessing if such matters are profitable and sustainable.

  • Unbilled time reports, which where possible should be produced on an aged profile basis, should be regularly reviewed (at least monthly) and circulated to the appropriate fee earners to assess billing potential or non-recoverable amounts requiring action.

  • Highlighting to fee earners the risk that the older the unbilled time the increased chance arises of its value diminishing or becoming non recoverable.

  • A policy of ensuring non recoverable unbilled time is removed from system on a timely basis is important as any overstatement of unbilled time could provide a false sense of security on future income / cash inflow.

  • Where permitted and practical, have an interim billing policy over a course of a client matter communicated to clients at the outset.

  • Some practice systems can set unbilled time or outstanding costs limits which can highlight when these are exceeded. This is of benefit for assessing interim billing requirements or having a policy of stopping work at that point.

  • Changing billing patterns so that unbilled income is converted into bills which are not solely issued at the month end will have its benefit in avoiding peaks and troughs within the working capital requirement. ( In practice this can be a challenging behavioural pattern to break!)

Outstanding unbilled disbursements / billed costs 

  • For disbursements and costs, wherever possible clients should be requested to make an upfront payment into the client bank account to cover these. General disbursements paid or incurred represent office money which can potentially be settled from any payments held on account.

  • For firms that do not have a separate credit control department, internal procedures need to be clear on who is responsible for chasing outstanding costs, i.e. is it the fee earners, cashiers department, etc.

  • As with unbilled time, regular reports showing outstanding costs preferably on an aged profile basis should be circulated to the fee earners responsible to monitor outstanding balances and take action as necessary.

  • Having fee earner incentive schemes based on cash collection rather than billing to encourage recovery.

In practice, managing lockup to improve the working capital position can at times be challenging not only in changing behavioural patterns in a practice, but also in balancing client relationships.

 

The above hopefully gives some practical areas which can be considered or provides some comfort to firms that they already have robust systems within this important area.   

                    

This publication is produced by Francis Clark LLP for information only and is not intended to constitute professional advice. Specific professional advice should be obtained before acting on any of the information contained herein. Whilst Francis Clark LLP is confident of the accuracy of the information in this publication (as at the date of its production), no duty of care is assumed to any direct or indirect recipient of this publication and no liability is accepted for any omission or inaccuracy.

 

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