How can firms improve cash flow as debt rises?

In November 2023, the total debt among the top 50 law firms in the UK hit £5.4bn. That’s a year on year increase of more than £175m.

As debt rises, cash flow will continue to dwindle if it’s not managed properly. This could have significant repercussions for firms’ long-term financial stability and their reputations.

We examine how law firms can ensure they remain resilient, when it comes to cash flow management.

A reduction in cash flow

Delays in client payments have often been a root cause of law firm debt. This continues to be an issue, with the average ‘lock-up’ time – the time taken from invoice to payment – increasing from 122 to 124 days, according to recent reports. As a result of this, firms may increasingly need to borrow money due to a reduction in their cash flow.

That’s not the only contributing factor. As three quarters of the top UK law firms integrate AI into their practices, embracing new technology has become critical for firms to remain competitive, boost productivity and enhance client services. But implementing new technology quickly can be costly.

Larger capital expenditures such as office refurbishments have also strained cash flow. They are costly to manage and have no immediate impact on a firm’s return on investment (ROI), so have no benefit to profitability. Available working capital soon becomes limited for a firm.

So what is the effect of these strains on law firms?

Reduced profitability, higher debt and liquidity challenges are just some of the repercussions. Not only could debt lead to a law firm’s reputation being put on the line, but increased liquidity challenges may make it difficult to expand business growth in the long term.

Smoothing out your cash flow

A few key strategies can help law firms to improve and maintain their cash flow during fluctuations in revenue.

1. Build a roadmap for success

Setting out a financial roadmap to plan for upcoming tax deadlines around cases can help law firms manage costs more effectively. If your firm identifies when seasonal fluctuations will occur, you can plan for different scenarios.

Review historic data as part of your planning. This way, you can analyse when previous dips have occurred and plan your finances more effectively to mitigate the risk of debt in the long term.

2. Diversify your income

Offering alternative fee structures, such as subscriptions, may help to provide more predictable income for law firms.

Monetising skills, by offering webinars or paid courses to educate customers, can also help expand a firm’s revenue streams. This means they can become less reliant on client payments and have confidence that money will continue to come into the business, even during lock-up periods.

3. Consider open banking

Use of open banking – allowing chosen financial service providers to access certain financial information from your bank – has surged across financial organisations, increasing transactional and operational efficiencies. Law firms can also adopt similar open banking solutions, in order to improve cash flow.

Open banking can result in faster payment times, lower fees compared to card transactions, and automatic reconciliation to handle follow ups. This can help reduce lock-up times between clients and firms, as well as providing more secure payment models. Faster payments can also lead to more effective cash flow management.

4. Spread the cost

By using the right forms of financial support in certain instances, law firms can also help smooth out cash flow during fluctuations in revenue. An informed, reliable broker can provide opportunities for law firms to receive competitive funding, which will help spread both seasonal and long-term payments over a period of time.

For long-term projects, such as an office refurbishment, funding can help get things up and running with minimal delay to daily operations. By spreading payments over a fixed term, firms don’t need to worry about large upfront costs. Instead, they can retain cash within the business as normal and free up working capital.

Lock-up periods with clients can occur at any time of the year, even during VAT and tax deadlines. But considering the right forms of funding to help cover these costs can ensure that firms remain compliant and don’t miss important deadlines, even when they’re waiting on a client’s payment.

Financial stability

Strong cash flow management is critical for law firms to remain financially stable and reduce the risk of debt.

A proactive approach and the implementation of regular practices, from strategic forecasting to financing, can help firms to be more resilient. This will support them to meet client and regulator expectations and pursue long-term growth, without a burden on their business and reputation.