In Industry Insights, Jon's Blog

Ensuring strong financial management is a key goal for the Compliance Officer for Legal Practice (COLP). Principle 8 requires that ‘You must run your business or carry out your role in the business effectively and in accordance with proper governance and sound financial and risk management principles’.

This is expanded into a regulatory requirement in Outcome O(7.4) of the SRA Code of Conduct which states that.. ‘you maintain systems and controls for monitoring the financial stability of your firm and risks to money and assets entrusted to you by clients and others, and you take steps to address the issues identified’.

There will be an overlap between the roles of the COLP (who is responsible for the firm’s compliance with the Handbook except the Accounts Rules) and the COFA (who is responsible for the firm’s compliance with the Accounts Rules i.e. protecting client money). Financial stability will certainly be the COLP’s remit, whilst in reality in many firms the COFA will probably be heavily involved in all the financial issues.

The reporting requirements under Outcome 10.3 and IB 10.4 of the Code of Conduct and Rule 8.5 of the Authorisation Rules also have a part to play. There is an obligation on the COLP and COFA to report “material” breaches……. “including serious financial difficulty” e.g. breach of banking covenants, not being able to pay PII, rent, salaries etc. COLP and COFA therefore need to be involved in, and have access to, all financial information, even if they are not the financial managers.

Specific requirements include:
IB(7.2) controlling budgets, expenditure and cash flow and
IB(7.3) identifying and monitoring finance, operational and business continuity risks…………..

These make it clear that the SRA expect there to be suitable systems in place, and monitored, so that breaches and financial difficulties can be identified. It is equally important that firms are able to demonstrate compliance i.e. not just having systems in place, but being able to show the SRA that the financial systems are collecting, analysing and reporting sufficient information to enable the firm’s managers to make appropriate decisions.

Where do you go from here?

What does this mean for the solicitor and his practice? And how can compliance be achieved?

It’s actually quite straightforward, and merely reflects the things that you should be doing to create and sustain a successful and profitable business.

The key to success in business is control. Without it you won’t be able to move the business in the direction you want, and thus achieve your objectives.

How do you get control? – By obtaining an understanding of all the factors that affect every area of business, and by ensuring that you devote sufficient resources to each of those areas (including external support if necessary) to ensure a successful outcome.

As regards finance, it’s all too easy to think of bookkeeping and accountancy as purely a compliance item, something required by someone else, and not used by you in your business.

Understanding the numbers, and what they mean, is key to making your business run efficiently and profitably.

Key elements

The Key Elements to getting it right are:

  • having functional recording systems that are fit for purpose and which will deliver accurate and timely financial information
  • having sufficient skilled financial management resources and systems to ensure that the financial information is converted into meaningful and understandable reports and analysed, so that correct management decisions can be taken to redirect the business as necessary.

Financial management

There are 3 important areas to be covered:

  • Profitability. The business needs to create enough net income (after deducting expenses) to appropriately reward the business owner, repay capital borrowings and to provide for future investment.
  • Capitalisation. The business owners need to have enough of their own capital invested in the business to ensure its continuation over the longer term, and to ensure the continued support of external sources of capital.
  • Cash Flow. The business needs to have access to sufficient cash resources to enable it to operate on a day to day basis. There has to be enough money available to pay the bills as they fall due.

Attention needs to be paid to all these areas, otherwise it will all fall apart very quickly.

Training in financial matters should be extended to almost everyone in the firm. The benefits of all fee-earners understanding the commercial reality of the work they do, and how they can have a direct influence on the firm’s financial health e.g. do they understand WIP and “lock-up”? This is especially important in small firms, where one solicitor’s poor cash flow management can have a significant impact on the operation of the firm as a whole.

How do you do it?

The key to it all is planning. Failing to plan is not far from planning to fail.

You need to have a clear idea of where you are going and what you want to achieve, otherwise you won’t have a chance of getting there.

It’s not an area that many of us are comfortable with but that’s no excuse for not doing it. The good news is that, like most things, the more you do it, the better you get at it, and the easier it gets.

If you don’t have the resources or experience within the firm to do this, you really should consider bringing in an external expect who can work with you to deliver a solution, giving you help designing and installing systems, training and monitoring. This will soon pay for itself, as it will ensure compliance with the Code, free up your time to work more effectively on your business, and give you the opportunity to increase profits through improved financial management.

Road map

The road map you can follow is as follows:

  • Set out your long term objectives (your destination)
  • Redefine these in terms of short term goals and targets (steps along the way)
  • Produce regular financial reports (working out where you are)
  • Evaluating these reports and taking actions as necessary to redirect your course.

The Practicalties

That’s what you have to do. Now, how are you going to do it?

1. Developing the Plan

You need to consider all 3 key areas – profitability, capitalisation and cash flow.

Once you’ve identified your aims, you need to consider resources required to achieve them and then define these in financial terms and convert them to money. This will show you the income and capital resources that you will require to fund the activity.

Consider the amounts required (quantum) as this will be needed for your income projections, and also the timing of the payments (including capital finance for long term assets) as this will be required for your capitalisation and cash flow forecasts.

You will now need to consider your income projections.

  • Look at your existing customer base, and look at what you expect to earn from them
  • Look at the clients you expect to gain during the future year(s) and what you expect to earn from them. Again, amounts and timing will both be crucial to your forecasting.

Going forward you will use this separation as a key plank of your development. Growth is achieved not just by attracting new clients – it’s also a matter of selling more to your existing clients, whose trust you’ve already earned, and who are aware of what a good job you do.

Then put it all together and, hopefully, you’ll get a positive result.

Start with the profitability forecast, and when that makes sense, move on to look at capitalisation and then cash flow issues. There’s no point in going too far until you’re sure that you can generate sufficient profitability from what you propose to do.

Don’t forget – the plan is not a document that you prepare to get you started. It’s a tool you should use to chart your progress and future success. It’s a living, breathing document that needs to be amended constantly from the information gleaned from your management accounts and elsewhere. Your buy-in to the process is crucial. This will keep you looking forward, and make the planning process a continuous part of your activity.

2. Actions

You need to consider and define basic ways of operating which will help your financial outcomes. If you don’t set these out at the beginning, you’ll find it hard to get back on track later.

Things to look at include:

  • Cash flow management – asking for payments on account, interim billing at regular intervals, and agreeing bills before they’re sent – a happy client will pay up much quicker than one who’s getting ordinary or poor service.
  • Credit control. Make sure payment of amounts due is effectively controlled and followed up. Fee earners won’t relish the responsibility of asking for payment, but if they take it on as part of their role, it will speed up collection no end. You will also need a centralised review and follow up system to chase the deviants.
  • Profitability. There is a balance to be struck. Profit equals Revenue less Expenditure. Look at maximising ‘profitable’ revenue (after the direct costs of doing the work) whilst minimising overheads. Each business is different, but the same basic rules apply.
  • Controlling overheads. Plan for the longer term but keep your costs lean. Make sure that you adapt and change where necessary.

3. Financial Reports

The key to success is having appropriate and robust systems which produce accurate and relevant information.

To do this, your system needs to be ‘joined-up’ and include:

  • A correctly installed and tailored bookkeeping system
  • Trained and skilled personnel, who are adequately supported and monitored
  • A rigorous and accurate reporting structure, monitored and verified by qualified personnel (external if necessary)
  • Integration into financial reports for compliance purposes

Communication is essential throughout the process, to ensure everyone understands all critical and relevant issues. All too often routines are performed in isolation by individuals – with unusual items being ignored/misunderstood and then the figures produced can be materially incorrect – which in turn leads to wrong conclusions being drawn.

4. Analysis and Review

It’s not the figures that are important, it’s what they mean – so detailed analysis and interpretation is crucial. You may need expert help and assistance with this, particularly in the early stages, until you’ve learned what to do and understand.

For the figures to be accurate, you need to pay a lot of attention to detail, and you may well find that quarterly profitability reports (management accounts) may be more relevant for decision making, and help produce a ‘balanced’ management response. Monthly figures can create an artificial urgency, and a knee jerk reaction, which may not be helpful in the longer term. Having said that, monthly figures should be obtained for KPIs (Key Performance Indicators) to confirm that you’re broadly on the right track.

5. Action Plans

The next stage is to review the Financial Reports in detail, and work out where you are, both in the context of your original plans, and where you could be in the light of prevailing circumstances.

You are now in a position to review your plans, and see how you can move forward, and continue the development process.

Conclusion

As you can see, it’s a straightforward process, and if incorporated into your regular management activity, will consistently deliver successful results.

It won’t necessarily be easy, but it won’t be difficult either. The more effort you put in, the greater will be the results, and the easier the process will get. It will also make it all far more enjoyable.

Just do it!

John Davey
Groves Davey Chartered Accountants

www.grovesdavey.co.uk

Groves Davey is a progressive firm of Chartered Accountants dedicated to providing business owners with the information and services they need to run their businesses effectively and profitably.

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