As the landscape of work keeps changing, law firms are assessing the damage and awakening to a new reality of declining legal demand and revenue. According to a recent survey by Citibank, law firms are projecting a 15% decline in second-quarter demand and revenue, which is partially driven by an 11% lengthening of the collection cycle.
To make matters worse, history has taught us that law firm demand does not simply bounce back in unison with the economy to pre-recession levels. Following the 2008 financial crisis, many law firms did not fully recover until the last quarter of 2010. But unlike 2008, where a timetable for recovery was fairly certain, 2020 is veiled with uncertainty.
To combat this uncertainty, law firms are understandably turning their focus to cash flow management. Facing declining demand and revenue, while expenses continue to mount, many law firms have taken steps to retain cash through salary cuts, layoffs, furloughs, delayed partner draws, and changes to summer associate programs. Many have also implemented hiring freezes and are reconsidering capital investments. All the while drawing down their lines of credit or looking for capital injections from partners.
What’s clear is that law firms need cash, and instead of looking outside of their firm, they should look inwards towards their reservoir of unpaid invoices and unbilled work to solve their liquidity needs. You may not realize it, but at any given moment, a law firm could have three to five months of revenue trapped in lock-up.
What is law firm lock-up?
Simply put, lock-up is the combination of unbilled work (WIP) and outstanding accounts receivable (invoices) owed to a law firm. This represents the total amount of outstanding cash that could be available for a law firm to use. According to various studies, law firms average between 110 to 140 days’ worth of earnings sitting in lock-up, before factoring in Citi’s projections of an 11% lengthening of the collection cycle. Reducing or accessing cash trapped in lock-up is an important lever to improve law firm liquidity.
How do firms access cash trapped in lock-up?
Firms can only access cash that they have invoiced, so it’s always important to convert WIP to invoices as soon as possible. But once a firm has invoiced a client, the most direct way is to reach out to your client and ask for payment. Unfortunately, many clients have long payment terms and are also suffering economically because of the coronavirus fallout. As a result, many are hoarding cash in an effort to drive liquidity and are in no rush to pay. This has led to longer collection cycles and a 25% increase of lost revenue due to unpaid bills compared to the months leading up the COVID-19 outbreak.
One solution to solve this liquidity crisis that is quickly gaining steam is the influx of supply chain demand-like programs that provide an early payment solution to law firms without impacting their client’s liquidity. LexisNexis® CounselLink® FastTrack is the most notable example of one of these programs. By using a third-party funding source, it allows law firms to request next-day early payment of a client’s invoices in exchange for a small service fee. This is an ideal source of liquidity since it does not act as debt, does not impact accounting, and is often a cheaper source of capital than many alternatives.
How can firms reduce lock-up in the future?
You can take action today to help reduce lock-up and improve the speed of converting WIP to cash. Here are a few tips:
- Invoice immediately when work is completed or an interim point is reached. The easiest way to speed up payments is to reduce the amount of time that WIP goes unbilled. According to a survey from Aderant, a majority of law firms take between one and three weeks to create an invoice for completed work. What is taking so long? Make it a goal to produce an invoice as soon as possible.
- Make sure everyone does their part to collect invoices. No one likes to pester a client for payments, and there is an understandably heightened sensitivity about the ability to pay following the pandemic. But the facts are clear: the longer an invoice is open, the less likely it will be paid. Follow up with your clients about late payments and have a straightforward conversation to figure out a solution, if necessary.
- Avoid surprise bills. If clients aren’t expecting a bill or there is a disagreement over billable hours, they will be less prepared or more unwilling to pay. Make a short phone call before billing to make sure you and your clients are on the same page about the cost and what they’re being billed for.
- Reduce your payment terms or offer discounts for early payments. It’s worth a try, especially when working with smaller clients. There’s no reason why you couldn’t get paid on 15- or 30-day terms. The problem is that your larger clients probably have significant leverage in negotiating payment terms. In this case, you could try to offer them a discount for early payment or see if they already participate in an early-payment program, like CounselLink FastTrack, which allows for next-day payments with service fees likely less than a discount negotiated on your own.
Lock-up is a problem faced by all law firms. With a few changes in behavior or taking advantage of early-payment programs, you can significantly improve liquidity by accessing cash already owed to you. Cash flow management has always been important for law firms but during COVID-19, with reduced demand and revenues, it is more essential than ever.