Excerpt from the Legal Cash Flow Report, Part 1: Understanding and Remediating Law Firm Profit Leakage in 2022

In March 2020 few would have predicted quite how successful the past 18 months has been for most law firms. Despite the pandemic and endemic global uncertainty, firms on both sides of the Atlantic are sharing in success.

All top 10 global law firms headquartered in the UK have delivered strong financial results, with fee income growth and an increase in reported profits, over the last year, according to the latest report from PwC, while most US firms increased their profitability, according to the Thomson Reuters Pandemic Performers Report 2021.

Not all business is equally profitable, however. As discussed in the BigHand Pricing and Budgeting report, there is widespread awareness that a rise in discounts, write-downs and write-offs could undermine firms’ abilities to maximize this opportunity: firms need to improve their understanding of profitability at matter/ client level.

Identifying Profit Leakage

As the law firm cash flow report reveals, firms have several significant areas of profit leakage to address, issues associated with both operational problems and inadequate client: law firm interaction.

In an era of digitalization, the widespread acceptance of inadequate processes is disturbing. Yet firms confirm that missing / late time entry (26% NA, 29% UK), a lack of matter budgeting (23% NA, 31% UK) and not using the right level of resource to complete phases and tasks (22% NA, 22% UK) contribute to profit leakage.

Client engagement models also reveal serious opportunities for profit leakage. Firms identify that underpricing work initially (25% NA, 30% UK) and poor scoping of work up front with the customer (23% NA, 25% UK) are problems – as we highlighted in the BigHand Pricing and Budgeting Report. 

Discounting is also a concern – with both standard rate discounts (25% NA, 30% UK), discounting at the point of billing and discounting to collect payment (29% NA, 30% UK) contributing to profit leakage.

Firms have significant changes to make if control is to be imposed throughout the client interaction.

Plugging the Gaps

Over 98% of firms in NA and the UK experience areas of profit-leakage that influence the firm's profitability – and they plan to take steps to plug the gaps over the next two years. The priority is to improve the visibility of financial data (28% NA, 29% UK), underlining a growing recognition that firms need better, faster, trusted insight into KPIs if they are to achieve any long term, sustainable reductions in lock-up / inventory.

Improved insight will be supported by the creation of new policies and processes designed to achieve a far more consistent, firm wide approach to financial client interactions that should unlock additional profit. Firms plan to review billing write-offs /downs (24% NA, 25% UK), standard rate discounts (21% NA, 25% UK) and collection write-offs / downs (26% NA, 21% UK).

In addition, firms (24% NA, 25% UK) plan to improve billable time entry, while 24% NA, 21% UK will put in monitoring systems to track leakage status regularly.

The speed with which firms make these changes will be key given the inflationary pressures affecting the global economy.  While plans to downsize office premises in response to the growing demands from employees for hybrid working will mitigate some of the cost increases, wage inflation alongside sign-on incentives and bonuses - is now accepted as a significant issue.

Rising interest rates and the cost of creating net-zero environmental strategies are contributing to a very different law firm cost model, reinforcing the importance of understanding profitability and imposing far better control through real-time monitoring.

Wider Implications of Cost Rises

Increasing staff costs also play directly back to client demands for work to be completed by the most cost effective resource, highlighted in the BigHand Resource Management Report. Without immediate visibility of the changing cost base across the organization, firms will be completely blind to the escalating costs and the profit implications.

How can firms accurately price work? How will firms identify if certain departments or matter types are experiencing stronger cost pressures or incurring higher levels of write-offs or client disputes? Law firms are entering into a new commercial landscape, and fast access to accurate data will be essential if firms are to keep on track with profitability goals.

This was an excerpt from The Legal Cash Flow Report. Access the full report to dive deeper into the findings from over 800 legal management professionals: