Chris O'Day, Chief executive of The Cashroom, highlights the opportunities to boost revenue and cash flow by focusing on utilisation and lock-up. (Updated 26 February 2020)
Pressure on profits and cash flow can make it difficult for law firms to invest in the new technology and marketing initiatives that will support future growth.
Increasing fee-earners' billable hours is a direct route to boosting revenues, but easier said than done. Improvements in utilisation are only sustainable if these represent value to clients, and if additional billable hours can be achieved without compromising other essential activities.
At the same time, the firm's ability to generate revenues will also be limited by the amount of work it can finance – in other words, by the amount of capital tied up in unbilled work-in-progress and in fees that have been billed but not paid. Unless the level of lock-up is controlled effectively, further growth will require reductions in the profits that can be drawn from the firm, or raising external funding.
The utilisation rate for a fee-earner is typically calculated as the number of billable hours worked as a percentage of a standard working week (for example, 40 hours). Adjustments may be made to avoid distortions from any holiday or sick leave during the period.
Utilisation rates vary significantly between different firms and different roles within a firm. Typically, billable hours targets increase over the early years of a lawyer's post-qualification experience, with senior associates particularly focused on maximising utilisation.
Rates of 150% or more (ie billing more than 60 hours a week) are targeted in some US firms with a long hours culture.
The Law Society's LMS Financial Benchmarking Survey 2020 used an average 1,100 chargeable hours per annum per fee earner (or 220 chargeable days per annum) for its breakeven calculations.
Utilisation rates for partners tend to be lower than other fee-earners. An increasing proportion of their time is spent on prospecting for new clients, maintaining existing client relationships, managing and mentoring team members, and involvement in managing the firm as a whole. In leading UK firms, partners nevertheless typically achieve annual billable hours of between 900 and 1,100.
By comparison, utilisation rates for sole practitioners may be much lower, with general administrative tasks (such as billing) often taking up more than 50% of available time. A sole practitioner without well-developed administrative systems and support may find it difficult to achieve double digit billable hours over the course of a week.
Market position and strategy can also significantly impact utilisation rates for the firm or for particular practice areas. For example, utilisation will tend to be low if developing a new market, while a firm facing pricing pressure may need to target higher utilisation rates to remain profitable.
"Recording and capturing all billable hours is important to appropriately assess the true cost, alongside maximising billing potential. However, ultimately it comes down to how much clients are willing to pay for the services provided, combined with an increasing client culture of fixed fee requests"
Jason Mitchell, partner, accountants PKF Francis Clark
In practice fee-earners work far more on client-related matters than is recorded as chargeable. Recording it all properly means you can then bill it correctly and price future jobs properly. This has far more impact on utilisation rates than chasing new instructions.
So, as a starting point, the firm should ensure that all fee-earners record their use of time. The system should record all work activities, not just time that can be billed to particular client matters. A good system will allow for the inclusion of brief notes on how billable hours delivered value to the client, making it easier to present and discuss costs with confidence.
Fee-earners should be encouraged to keep time-recording up-to-date and submit completed time sheets promptly. Resistance to time-keeping, or shortfalls in total recorded hours, should be discussed with the fee-earner as a priority.
Monitoring hours like this encourages everyone to focus on how productively their time is being used. Non-billable hours spent on client relationships and supporting the team may be fully justified.
Administrative tasks that use up excessive fee-earner time may represent opportunities to introduce more efficient systems, outsource or delegate to support staff.
Analysis of billable hours allows you to see how profitable each practice area or different types of legal service have been over the preceding period. Low utilisation figures suggest over-staffing for the available work. The firm may need to invest in developing new business, or take a more defensive posture by reducing headcount. Conversely, high or increasing utilisation rates suggest an opportunity to hire new talent and grow the business.
"There's a tendency to overestimate utilisation. Simply monitoring the numbers helps shine a light on what is really going on"
Darren Cable, UK head of legal practices, Lloyds Bank
Tracking utilisation rates over time gives you an early indication of new opportunities and potential problems. If utilisation is falling, why? If utilisation rates are increasing, what are the implications for work quality and stress levels?
You can compare utilisation rates for individual fee-earners and between different practice areas – but with caution. Investigate and discuss low utilisation to try and understand why rates vary and what, if anything, should be done about it.
Equally, outstanding utilisation may provide opportunities to identify and spread good practice. If one fee-earner consistently outbills colleagues in the same practice area, why?
Publicising utilisation rates and trends within the firm can be a good way to stir peer pressure to improve performance. Again, care needs to be taken to provide a fuller picture of how rates are affected by circumstances and to avoid creating unhelpful conflict. Utilisation rates should be only one of several metrics – including, for example, what percentage of billable hours is actually recovered.
Benchmarking against other firms can be a useful way of picking up ideas for potential improvements. The Armstrong Watson Legal Sector Benchmark annual report is full of useful information. As mentioned, smaller firms typically underperform legal sector averages, often because they need to invest more in the technology and systems that will improve efficiency.
You can extend this idea to include benchmarking against other professional services firms – or even completely different sectors – to prompt more radical ideas. It may well be easier to share details of your business practices with your accountants than with a competing law firm.
"Yes, utilisation rates identify the opportunities to improve, but be aware that low chargeable hours for a fee-earner can disguise a host of factors ranging from a lack of training on the systems to a busy BD programme being undertaken by that person"
Emma Shipp, corporate solicitor, Russell-Cooke
Misuse of utilisation targets
Setting utilisation targets can help focus fee-earners' attention on the importance of billable hours and help motivate improved performance. But careless use of targets can create undesirable effects. For example:
- Setting utilisation targets for trainees and junior lawyers – who may have little control over how many billable hours they work – can cause unnecessary stress or even the temptation to pad time sheets.
- A focus on billable hours pushes fee-earners to deal with matters exhaustively – even if this is not what clients want. This can create a perception among clients that their lawyers are more concerned with maximising billable hours than with providing good value, and an increased risk of fee disputes and write-offs.
- Partners focused on their personal billable hours may be less willing to delegate, and reluctant to spend time on non-billable (but vital) activities.
- An excessive focus on utilisation may conflict with the firm's efforts to create a culture that will attract new talent and help develop more rounded lawyers as part of succession planning.
A better system may be to track and target overall utilisation, by practice area or team. Similarly, partners can be made responsible for junior lawyers' utilisation, encouraging the partner to manage and support them.
"Imposing unachievable targets is demoralising, particularly when people feel that they cannot influence the outcome"
Andy Poole, partner, accountants Armstrong Watson
Across the legal sector, year-end lock-up increased in 2020 to an average of 125 days. The number of days taken to collect debts decreased slightly from 59 days to 58. But the average time taken to bill work in progress (WIP) increased from 61 days to 67 days, as one would have expected. Work has taken longer to complete due to staff being on furlough, child care responsibilities and slow response times from other sides. This is bad news for law firms, as the additional free cash could have been used for improving the business and/or reducing capital requirements, thereby aiding succession.
For firms involved in areas like complex medical negligence claims, or with lax collection procedures, lock-up can be substantially higher.
Lock-up can have a dramatic impact on the law firm's profitability or even survival.
- Lock-up needs to be financed, either by reducing partners' drawings from the firm or by raising additional funding. Banks may well be unwilling to lend against work-in-progress, and even borrowing against outstanding invoices can involve significant costs.
- Limiting the total cash locked-up inevitably means limiting the amount of work the firm can undertake. Without additional funding, the firm cannot grow.
- The firm is at risk until payment has been received. If a client disputes fees, or becomes insolvent, the money may never materialise.
At a strategic level, the firm needs to take a view on what kinds of work it wishes to take on and whether to limit exposure to matters that involve high lock-up. Look at how much profit each practice area generates in comparison to the capital it ties up. With limited funding, it may make more sense to concentrate on growing areas that offer a high return on the capital employed.
Similarly, you may want to limit or completely avoid exposure to no-win no-fee work if the impact on lock-up outweighs expected returns.
The Law Society's Financial Stability Toolkit is a good starting point for improving utilisation, lock-up, and all aspects of the financial health of a firm.
"Just a few days improvement in lock-up can add up to big sums of cash very quickly. There are many 'easy wins', but the easiest is to final bill quickly and not to wait until a month end comes around."
Glyn Morris, partner and ex-finance director, Higgs & Sons
Practical steps to reduce lock-up
Improving lock-up starts from the initial contact with the client. Make your payment terms clear in the engagement letter. Where appropriate, negotiate a retainer or interim payment. Agree in advance when disbursements will be billed to the client.
Be clear about the expected level of fees, and keep the client up-to-date as matters progress. Resist the temptation to put off discussing any fee over-runs until you submit the final fee note, as this usually leads to additional payment delays while clients argue for a reduction. If you expect a bill to be contentious, aim to discuss and agree any write-off before issuing the fee note.
Aim to progress matters as quickly as possible. In some practice areas, it may be possible to reduce lock-up by limiting the number of cases taken on simultaneously. This should allow you to progress each individual case more quickly, speeding up eventual resolution and payment while improving client satisfaction. At the same time, look out for any bottlenecks that delay case progress – for example, slow responses when work is delegated within the firm or when using external barristers.
Once a matter has been resolved, a final fee note should be issued straight away and followed up with monthly statements of account as long as there is an outstanding balance. Rather than leaving fee-earners to (reluctantly) chase overdue payments, you may prefer to hand overdue accounts to a dedicated credit controller within your accounts team – while keeping the fee-earners involved.
If the firm is involved in litigation, it's worth appointing a costs draftsman (or using an external provider) who can produce bills of costs and send them to the court as quickly as possible. Any costs litigation should be negotiated by a specialist costs lawyer.
"Getting buy-in from partners is much easier once they see the direct link between utilisation, lock-up and their own incomes"
Vidisha Joshi, Managing director, Symphony Legal
Most partners have an instinctive aversion to getting involved in billing issues. Some prefer to focus on the law, while others worry that payment conversations with clients risk damaging the relationship. But partners' behaviour is critical.
- Present numerical data in simple, impactful ways – for example, a monthly cash flow graph showing performance against target and against the previous year.
- Turn percentages into cash equivalents – for example, showing the cash impact of each one percent improvement in utilisation or one day reduction in lock-up.
- Publicise levels of write-offs and under-recoveries. Highlight how recovery rates fall the longer overdue payments are.
- Base partners' profit shares on the firm's cash flow, not billings or work-in-progress. Consider including utilisation and lock-up performance among the factors which determine each partners' profit share.
- Keep partners informed throughout the year, with monthly reports on billings, cash flow, work-in-progress and aged debtors.
- Get partners to take responsibility by signing off on all significant write-offs in their practice areas.
"It's not unusual for lock-up to fall at year-end – when partners know it directly affects their income – but rise again afterwards"
James Kerr, head of professional indemnity, Travelers
Utilisation and lock-up top ten
- Be realistic about how much time you want fee-earners to devote to non-billable activities.
- Set all fee-earners a target for total recorded hours – not just billable hours.
- Track trends in utilisation rates over time and identify the causes.
- Recognise the underlying causes of variations between different individuals and practice areas.
- Identify and share best practice.
- Consider benchmarking against other firms.
- Take lock-up into account when setting strategic priorities and deciding where to focus growth efforts.
- Institute businesslike billing and credit control practices.
- Address potential billing overruns and disputes at an early stage.
- Incentivise partners to recognise their roles in improving financial performance.