Managing the finances of a law firm: Donns collapsed owing £2.4m to Co-op Bank

Ian Hazeldine, Finance Director

Managing the finances of a law firm, especially in the current climate, is very demanding – but of course I would say that.

However, what went so wrong here? A well respected firm in a fine city, operating in a buoyant market too. And financed by that most prudent of banks, Co-op.

The clue is in two words referred to a couple of times in the text – “historic liabilities”. What this means is a business such as this has not only to match the competition but has to do significantly better than the rest. Its like asking Usain Bolt to run a 100 metre sprint carrying a bag of sugar. Not only is there obviously the extra weight to transport, but there is the added inconvenience of not being able to move both arms freely for fear of dropping it.

Similarly when a business has “historic liabilities” not only is there the extra requirement to generate super profits to eventually clear these liabilities, but there is the added administration of keeping the “historic creditors” happy. So, you have to perform better than the competition, and do so with a handicap.

Law firms generally are very good at watching their cash. However I am always surprised at their reluctance to look ahead at the non-cash leading indicators of future cashflow. Regardless of how low your lock-up is if you are not making a reasonable profit you will never generate cash. Furthermore if your gross margin isn’t healthy then you will never make a profit.

Going further, a fall off in the number of incoming new matters tells you that in all likelihood your margins will be coming under attack unless you act. And if the number of enquiries you are getting is falling then your new matters will most likely reduce too. So, falling enquiries today tell you that your cashflow will be under pressure this time next year.

This of course is my very simplistic view, but the key point is that it is no good placing too much emphasis on what your cash position is today because it could easily be too late to do anything about it if you don’t like the answer. But you absolutely must predict how your cashflow is going to fare over the medium term future.

I do not know what happened at Donns. In fact turning over £8m with 42 staff and just one equity partner suggests that the gross margin ought to be unbelievable. Perhaps that was the problem?