Publishing Profit and Loss Accounts: Problems in for SME Law Firms

As things stand, from 1 April 2027 far smaller firms will need to file a profit and loss account at companies house than is currently the case

"Far smaller" being firms with some combination of >£1m in turnover, 10 employees or £500,000 balance sheet total

There has been a lot of noise, across all sectors, around this in recent months and the rumour mill suggests the plans may be shelved or deferred in the interests of not increasing red tape and bureaucracy

Putting that noise and reading of the tea leaves to one side, there were three three specific objections I've been hearing from law firms:

1. The impact of client interest on overall law firm profitability

The concern being that by showing this in the published profit and loss would be commercially disadvantageous

2. WIP valuations in the balance sheet causing an outsized impact (for better or worse) on turnover and therefore profitability

Potentially with material swings from one year to the other and ultimately a mismatch between profit and cash, and needing to manage partner expectations around drawings

3. Greater visibility of financial performance for staff may prompt difficult conversations

Similar to managing partner expectations - a need to explain the difference between fee income, costs such as fee earner salaries, and profits distributable to partners

Whilst I agree that publishing P&Ls highlights these issues, my view is that to object to P&Ls being published on these grounds is somewhat missing the underlying business issue

i.e. the accounts are only showing what's there

And if what is there is an overdependence on client interest, a mismanaged WIP balance or concerns around staff understanding of finances - then it is those three issues that need tackling, regardless of whether or not smaller firms are ultimately forced to publish those issues openly on companies house for the world to see

Working with 1 April 2027, it is within the gift of most firms to tackle those issues before they see the light of day

And so, taking each issue in turn...

The impact of client interest on overall law firm profitability

Interest earned on client account is something of a thorny issue and a hot topic currently

I see four different, but overlapping considerations:

1. The MoJ's ILCA live consultation on channeling client interest away from firms and into a central fund

   
   

2. The Law Society's 2025 financial benchmarking showing that practically all of SME law firm PEP increase was driven by client account interest and, in recent weeks, a reiteration of the vulnerability of SME firms to the MoJ's proposal

   
   

3. The SRA's consultation earlier in the year on the broader model for client accounts (i.e. should solicitors hold client money at all)

   
   

4. Protestation from SME firms at potentially publishing full profit and loss accounts at Companies House from April 2027, for fear that they show the extent to which profits are propped up by client interest

Taken together, we can see a picture of a shift in regulatory appetite for solicitors to continue to benefit from client account interest - be that by removing the interest (MoJ) or the account entirely (SRA), combined with a recognition that SME firms are financially exposed to that potential regulatory shift

In recent years, as rates have increased, client account interest has propped up and masked flat or declining financial performance. The same benchmarking report referenced at (2) highlights low utilisation rates as a particular stress point and I'd add that pricing is another issue - lowballing on headline price to win the work, knowing that you'll make up the difference on client account interest

In the short term, it may appear sensible to lobby against the proposed regulatory changes and defend the status quo, but it strikes me that the tide is turning. Firms need to to take a serious look at the underlying commercial sustainability of their businesses

My long held, but admittedly not always popular, view is that client interest should be of negligible impact on overall firm profitability - it's a law firm, not a bank

A sustainably run firm should be generating sufficient profit from core legal services and with these various shots across the bow - now would be a good time to revisit the underlying commercial model and reduce dependency on client interest

WIP valuations cause a disconnect between report profit in the profit and loss account and cash on the balance sheet

This is a symptom - not a cause

The underlying issue is an excessive build up of WIP, and it is this issue that firms need to address

As a reminder, WIP is the value of work performed but not billed

If year end WIP balances are high, this inflates profit in the P&L but, as it's a non-cash item on the balance sheet this can give the impression that the firm is healthier than it perhaps is by the time that WIP converts to billing and cash

There's a degree of judgement applied to those WIP valuations and law firms can be, let's say, somewhat optimistic in applying that judgement - particularly when you look at the underlying WIP ageing

Practically speaking, there are steps firms can take on to reduce the impact of year end WIP beyond just billing everything on the last day of the year...

1. I've not met a firm that doesn't have an increased focus on billing in the run up to year end, but bringing that focus forward to the end of Q3 can bring billing and collections forward, reducing year end WIP (and debtors)

   
   

2. As a build on (1) - monthly, quarterly and annual billing cycles are (in large part) arbitrary and (generally) lag the underlying transaction. Tie billing to matter milestones and deliverables rather than waiting until month- or year- end, to shorten working capital cycles

   
   

3. For transactional matters (real estate, M&A etc), move away from billing on completion and agree interim billing arrangements. "But it's standard practice in the market" isn't as true a statement as you think it is

   
   

4. Be realistic (rather than optimistic) on WIP valuations. If you're recovering 70p in the £1 on standard rates in the preceding 12 months, you're unlikely to be recovering more than that on year end WIP - sense check year end valuations to historic cash realisation rates and increase provisions accordingly

   
   

5. As well as prioritising year end billing, don't lose sight of cash collections throughout Q4. Whilst valuation is typically less of an issue with debtors, utimately - only cash is cash

Jamie Pennington and Steve Rowan both flagged the merits of the US approach of recognising income on cash collection - rather than at billing. There certainly seems to be greater discipline in those firms

In contrast, UK law firms have long grappled with poor discipline around working capital, for smaller firms the better performers have less than 43 WIP days outstanding with the worst performers holding in excess of 150

A wide range that bears little correlation to differences in practice or client mix

Perhaps the threat of publishing full P&Ls at Companies House will finally focus minds on basic financial housekeeping

"Publishing P&Ls may prompt difficult conversations with staff around financial performance"

At first glance, this might indicate the firm is struggling financially and staff will worry

But no, as I've heard this articulated (more than once!), it actually means "but the staff will see how much the partners earn"

Partners are obviously entitled to run their firms as they see fit, but I've never been convinced that running them in secrecy is a wise course of action

As a general rule, if you want strong firm performance - making all staff aware of what good looks like and what their contribution to that performance is far more likely to result in improved financials than leaving it to staff speculation and the rumour mill

Hope is not a strategy, and all that

Or, as Mark Johnson put it "transparency with financial information across your organisation drives better results"

For the smaller firms concerned with publishing P&Ls come April 2027, I'd advocate for grabbing the bull by the horns and proactively upskill staff on how the firm is financially successful, and what non-partners can do to make it more so

To tackle the partner remuneration point head on

We approach this within The Legal MBA by highlighting the difference between remuneration as a fee earner and remuneration as a shareholder in the firm

Folks understand the distinction that, in other businesses, the staff will receive a salary and the shareholders will receive a dividend

The quirks around how partner remuneration (comprising both of those elements) is presented within the firm's financial statements is then relatively straightforward to walk through once that distinction is understood

If you're worried about what people think about partner remuneration in your firm - better address it and communicate it well, rather than ignore it and leave people to fabricate their own narratives

Graeme Johnston raised the related concern around SME firms publishing a bumpy performance at Companies House - potentially unsettling staff, or a bumper performance - potentially encouraging larger clients to push for greater discounting

I see this concern voiced more generally across sectors and affected SMEs, more broadly than just law firms, and it is valid. Whilst I'm not convinced that publishing P&Ls at Companies House substantially increases the admin burden on firms, in and of itself - there is clearly going to be a greater need to communicate and manage expectations around those published P&Ls - both internally and externally

Summary

It's an open question as to whether or not SME law firms are required to publish P&L accounts from 1 April as currently legislated. As Secretary of State for Business and Trade, Jonathon Reynolds has publicly stated that he is against the requirement and so we may see this formally deferred, or removed later in the year.

However, the resulting debate and discussion has surfaced some underlying problems SME law firms face with publishing P&Ls, namely:

The impact of client interest on overall law firm profitability

WIP valuations in the balance sheet causing an outsized impact (for better or worse) on turnover and therefore profitability

Greater visibility of financial performance for staff may prompt difficult conversations

Acknowledging that this may appear unsympathetic but, even if the proposed changes are not delayed and are implemented from 1 April, firms have sufficient time to tackle the underlying issues before they are aired in public

It strikes me as prudent to do just that