Lockup is a perennial issue within law firms, with the most recent PwC survey showing deterioration in the amount of time it takes law firms to get paid to ~145 days.
This means that, in the 5 months it takes for cash to come in the door, the firm will have paid 5x salaries, 1-2 VAT returns (including on the bills it's not collected) and 1-2 rent payments.
These are big cash outflows that are being funded, either by partner capital or debt. Both of which have become increasingly expensive to finance in recent years.
But how best to tackle this?
In The Legal MBA, we wanted to equip those working within law firms with the tools and frameworks to help solve real problems within their firm. It's important to us that there is real world, practical impact.
This guide to improving lockup illustrates this, drawing on the operational, process improvement models in Chapter 5 of The Legal MBA Essentials and the insights on financial management in Chapter 7.
As a problem area, lockup lends itself well to a Lean Six Sigma approach to solving. It's essentially a problem of reducing elapsed time in a process (the time from a fee earner working a file, to cash being collected), for which Lean is very well suited.
This isn't just theoretical, this is the same approach we've used in past consulting engagements to reduce working capital by £5m in a £100m turnover firm, and a £30m reduction in debtors in a £300m turnover region.
These were reductions in lockup and debtor days of 10% and 30% respectively; this is a very powerful approach.
We introduce Lean Six Sigma in Chapter 5 of the Legal MBA Essentials, but in this guide we'll step you through the DMAIC process to show you how this can specifically be applied to improving law firm lockup.
D... is for Define
The first step is admitting you have a problem.
And defining it, in a simple written statement.
For lockup, there are in essence two lockup issues and you may want to focus on one or both:
Cashflow - need to reduce the amount of working capital needed to operate the business, typically evidenced through approaching the limit of partner or bank willingness to lend further
Profit Leakage - need to reduce interest payable on borrowings (increasingly relevant, currently), or reduce write offs throughout the billing and collection cycle
Generally, cashflow is the bigger issue and so we'll focus on that here, but write out your problem statements in the form:
Our lockup is too high at [145 days] causing strain on the balance sheet [and the willingness of partners and the bank to fund our working capital requirements].
We aim to reduce our lockup to [120 days] by [the end of the financial year], by looking to reduce the time taken to raise [and/or] collect against our bills.
Feel free to edit [...] to make this more relevant to your firm.
For context, in a £20m turnover firm, the 145 to 120 day reduction (~7%) in lockup in the above example is a ~£1.4m reduction in working capital requirements. These are big numbers we're talking about, and worth looking at.
Note that your problem statement should articulate the current state and the problems it causes and the desired state with the areas of focus you're going to tackle.
You'll likely revisit this problem statement once you've undertaken the next stage; Measure, but it's worth articulating a statement of intent at this stage.
M... is for Measure
The purpose of the Measure phase is to establish how the end to end cash cycle is performing currently.
Key to this phase is a process map, documenting the key steps and systems from the point the fee earner performs the work, through that time being captured on a bill, despatched to the client and ultimately being settled.
In chapter 5 of The Legal MBA Essentials we recommend a swim-lane flowchart for documenting end to end processes, and this works well for this exercise.
At it's simplest, the key process milestones are:
Date work performed
Date time recorded in the time recording system
Date bill raised
Date bill despatched
Date bill settled
Assuming your firm has reasonably modern systems, you can typically extract granular data on the first two items from the time recording system, and the last three items from the Practice Management System.
The data the bill is despatched can be a little difficult to get at, as this is often an offline step.
Never one to let perfect be the enemy of good (enough) you can address this gap with manual sampling and checking back to post/email dates.
You need to get the actual data for your firm, as you want to focus your improvement efforts on where they'll have most impact.
That said, and for the purposes of this guide, in chapter 7 of the Legal MBA Essentials, we show the typical issues and delays in collecting cash. For the typical UK law firm, the main components of lockup are approximately:
10% due to poor time recording habits
40% due to delays in billing
10% due to delays in despatching the bill
40% due to delays in collecting on issued bills
Poor time recording is generally a source of write offs and profit leakage, but from a cashflow perspective it's your billing and collection processes that are likely to have most impact, and so we'll focus our attention here.
Before moving onto the Analysis phase, revisit the target in the Define phase for your findings here.
A... is for Analysis
The key to this stage is identifying the improvement actions that are going to give you most bang for buck in terms of your overall objective of reducing lockup.
The key challenge is the risk of analysis paralysis and never getting to the improvement actions for staying in spreadsheets too long.
You can get really technical, really quickly here in terms of statistical analysis but, from experience, if your lockup is north of 100 days it's almost certainly due to certain outliers dragging out that performance (e.g. one really big, slow paying client) rather than the process is generally taking 100 days for all clients.
Based on the initial measurement of the end to end lockup cycle in the Measure phase above, you should be able to cut the data from the time recording and practice management systems a number of ways to help hone in on the key problem areas.
I would typically recommend looking at lockup by:
client
client relationship (and/or matter) partner
office
practice area (or industry/sector, depending on how the firm is structured)
In each case you are looking for those clients, partners, offices and practice areas that are (a) big in revenue terms and (b) have high lockup.
Rank your biggest problem areas using a weighted average (revenue x lockup days) and then highlight the areas that will deliver the majority of your targeted improvement.
You'll likely find that ~80% of the improvement will come from ~20% of the areas in your list, or similar (H/T Pareto).
Focus on those small number of problem areas, to drive an outsized improvement on performance.
But before you rush in, take some time to understand what's causing the delays in those areas; speak to partners, billers and credit controllers familiar with these files and see if any themes emerge across the areas.
An easy to use model we suggest in Chapter 5 is 5-whys, which is essentially to channel your inner toddler and keep asking 'why?' until you reach the underlying cause for any particular issue.
Those underlying themes, or root causes, will have a bigger impact across the firmwide lockup cycle compared to just addressing them for one client/area.
Common examples of these themes might be, (i) issues in client/matter opening, (ii) poor payment terms in engagement letters, (iii) issues in the billing or collections teams, or (iv) poor internal time recording/billing policy design or compliance.
Having worked out which areas are going to make biggest impact, we turn our attention to making the improvements.
I... is for Improvement
In chapter 5 of The Legal MBA Essentials, we introduce both Project Management and Change Management as disciplines to making improvements within the operations of a law firm.
Project Management is concerned with balancing the iron triangle of timescales, cost to implement and quality (or scope) of the implementation.
By focussing improvement areas in the Measure phase on those that will give most bang for buck, this sets up your lockup improvement project well in terms of scope and cost to implement, which means you can focus on timescales.
You may well have some quick wins (e.g. negotiate a settlement on that large delinquent account), but there needs to be a dose of realism here - if it's taking the average firm 5 months to collect cash, you're not going to reduce that to 3 months within the next week.
Set realistic timeframes for implementation and when lockup reductions can be reasonably expected.
Finance teams are a key stakeholder to manage here.
It's likely the CFO/FD that's flagging the need to address lockup, and the wider team will likely have supported in the Measure and Analysis phases above.
But often it's the partners and fee earning teams that need to pickup the phone to difficult clients, or unpick a mess of time narratives on old files.
These aren't fun tasks, and they'll quickly fall off the to-do list; but it's important that Finance teams work with, and support, fee earning teams in making the improvements rather than get frustrated and fall into a nagging role.
For wider behavioural changes (e.g. improving time recording or billing disciplines), the ADKAR change management model is worth considering.
Not everyone knows (read: cares!) that there's a problem with lockup, and so a change management programme that takes the relevant teams from Awareness of the problem, through Desire to help, Knowledge on how to help, Ability to make the required changes and Reinforcement of the behavioural changes is key.
This is so much broader than 'get your timesheets in by Friday' emails, or another mandatory training on the firm's billing process, but it really is essential to making the changes stick over the longer term.
C... is for Control
This stage is often forgotten in the excitement of achieving the targeted improvements, and should be understood in the context of sustaining those improvements over time rather than letting lockup deteriorate again.
For better or worse, firms generally work to a monthly billing cycle and then a more infrequent WIP valuation cycle (ranging from quarterly to annually).
Rather than fight these trends, align your reporting on project progress against these.
So build in lockup targets for individual partners that are measured at month end (or first working day of the following month). Debtor days targets are particularly effective on this cycle.
If your WIP valuation exercises materially impact the carrying value of Work-in-Progress then report on WIP lockup alongside those exercises.
This removes the noise and excuses around 'it's only bad because the valuation hasn't been done'.
Assuming lockup is of strategic importance to the firm (spoiler: it is!), make sure progress against any improvement plan is being reported alongside existing financial information; be that monthly management accounts, or presentations to board.
To reiterate - key here is aligning the reporting and control activities alongside the existing reporting and control activities within the firm, not to create a new process that sits outside and potentially in conflict with that cycle.
Conclusion
There we have it, a step-by-step guide to tackling law firm lockup, in summary:
Define the problem you're trying to solve
Measure the performance of the current working capital processes
Analyse the issues and identify the root causes
Improve the process
Control the process by monitoring against the agreed targets
In creating The Legal MBA, we wanted to give those working in law firms the tools to better understand their business and take practical steps to improving it.
In this guide to improving lockup, we draw on the models from Chapter 5 and Chapter 7 of the Legal MBA Essentials.
You can also find supporting templates and exercises, such as swim-lane flowcharts and root cause analysis within the accompanying Workbook.
The Lean process outlined here is particularly powerful for addressing issues with elapsed time, so in addition to lockup, it works well in reducing delays in matter opening/client onboarding or issues in legal service delivery relating to turnaround times.
Both The Legal MBA Essentials book and accompanying workbook are available at www.thelegal.mba
Comments