Bristol’s law firms are “tiptoeing across the slimmest of financial tightropes” despite their revenues reaching record highs, according to new research.
The in-depth analysis of the accounts of the UK’s Top 50 law firms, many of them with offices in Bristol, by accountancy group Smith & Williamson, also points to possible mergers between some of the larger and mid-tier firms. 
The research, which looks at issues such as levels of debt and profit margins, also unearthed a raft of concerns in the legal sector, including uncertainty around Brexit, the amount of money owed to law firms and whether the sector could survive another economic shock.
Smith & Williamson partner and head of professional practices in Bristol, Fiona Westwood, pictured, said: “The Top 50 law firms had fee income of over £16bn in the most up-to-date audited accounts and nearly every major law firm has heralded their investment in technology. However, key barometers of efficiency appear to be questioning how healthy the sector really is.
“When the figures are examined in detail, a worrying trend emerges regarding the efficiency of law firms. Over half (26) of the Top 50 have profit margins down year-on-year.
“While on average the profit margins of the Top 50 firms are down only slightly – from 31% to 30% – this follows a continuing trend over the past three years where operating profit margin has slipped by 1% each year. This is during a period where firms have been investing increasing amounts into IT and different ways of working to improve efficiency.
“Operating profit margin is one of the key indicators of efficiency within an organisation. The fact that margins are falling suggests that firms have to work harder and harder just to stand still and that they are tiptoeing across the slimmest of financial tightropes.”
Fiona said the fall in the value of sterling since the Brexit vote may be masking problems under the surface at many large firms.
“Following the referendum the value of sterling declined over 10% against the dollar and other major currencies. A significant number of the Top 50 law firms are international, with a proportion of their income being received in foreign currency, so the currency movement gave them an additional sterling benefit,” she said.
The Smith & Williamson analysis also reveals that £5.2bn is owed by clients to law firms – up 9% from last year – and almost £2bn is unbilled, up 6% – so-called ‘lock up’.
“This is a staggering amount of money left unpaid on all of the Top 50 firms’ balance sheets,” Fiona added.
“Law firms are missing out on nearly £7bn of additional cashflow. This only includes work they have the realistic prospect of being paid for: it is highly likely that many firms have elected to write-off additional amounts incurred in delivering the service, due to inefficiencies.
“The economic situation for all businesses is potentially quite uncertain and the ability of law firms to survive an unexpected shock might be questioned. Based upon research across the Top 50 law firms, the total net cash position of all the firms would be insufficient to pay the next month’s wages.
“Firms are therefore entirely reliant on their clients continuing to settle their debts. Not only is this position gradually getting worse, it makes the ability of a firm to deal with the unexpected that much harder.”
Fiona Westwood believes that the Smith & Williamson research points to increasing merger and acquisition activity among the South West’s law firms in years to come.
She says: “Every firm in the Top 50 is an immensely profitable vehicle yet a number of the firms, particularly outside the top 10-20, have had declining profit margins for years. So while income may be rising the challenge of generating a sufficient return is becoming harder for some firms, who may feel the opportunity to merge with another firm will provide a way to reverse this decline.
“Smith & Williamson’s most recent law survey identified that 25% of the respondents were considering mergers and acquisitions as the biggest opportunity for their firm over the next two to three years. However, 80% think that competitive pressure in the legal profession has increased over the past 12 months.
“Law firms, like all businesses, need to stand out from the crowd and one way of doing that is through scale or specialisation.”
