A Bump in the Road on the Way to Recovery
Since 23rd March 2020, we have probably seen the most challenging time in anyone’s career in terms of how to manage a business. There is no textbook that one can refer to on how to get through this and we have had to rely on our own skills and expertise, and those around us, to help. It probably feels in some ways that the hard work has now been done, as there are glimmers of hope that we’re on our way to recovery with the opening of the housing market, social distancing rules being relaxed more and more, and businesses starting to re-open.
From a finance perspective, the only real Government support that law firms have seen is the furlough scheme which has softened the short-term impact of COVID-19. All other support from the Government has really been about deferring financial issues until another day in respect of VAT, PAYE and income tax payments.
On the face of it, a lot of firms’ finances are probably currently in better shape than anyone could have predicted at the beginning of this pandemic. Most firms have more cash than expected due to the deferment arrangements, furloughing and the encouragement for fee earners to bill as much as possible and clear out work in progress. However, behind the scenes, with the clear down of work in progress, what is happening is that as activity levels reduce, that work in progress is not being replaced at the same rate.
Just when you are thinking that you are back on track, the reality is that there is a potential large bump in the road on the way to recovery, and this is going to happen in quarter one of the calendar year 2021.
The reason for this is that all of the deferment offers by the Government, which most firms took, will crystalise in that quarter. This is the VAT payment up to July 2020 and for many, this VAT payment will be exceptionally large in comparison to perhaps what firms are paying at the moment, as it was a very busy quarter, and it will also happen at a similar time to another VAT quarter, so effectively paying six months’ worth of VAT in one go.
In addition, there will also be three tax payments to make, being the second payment on account for 2019/20 which is normally payable on 31 July 2020, the sweep-up payment for the set of accounts falling in the tax year ended 5 April 2020, and the first payment on account for the set of accounts falling in the tax year ending 5 April 2021.
For practices that have a year-end other than March, the second payment on account and sweep-up payment is potential for a very good year, i.e. April, May or June 2019. Having a year-end which does not coincide with the tax year, is great when business is brisk and money can be put aside for that and invariably used as part of the business’ working capital. However, when activity levels reduce after such a good year, the temptation is to use the cash generated from those profits to help the business, which then, unfortunately, means it is not available then to pay the tax when it becomes due.
There are many things that a firm can look at, to help in relation to their tax payments due at the end of January 2021. It just means speaking to your accountant and planning in advance.
No doubt, with so many businesses in a similar situation, the Government will probably offer some form of “time to pay” arrangements, but one should not rely on this as a guaranteed way of dealing with it.
The main issue that a firm needs to focus on, on their way to recovery, is the balance of the rebuilding of work in progress and how quickly that can be converted into cash versus the cost of creating it. One of the challenging issues of managing working capital at the moment is that matters are taking longer to complete and therefore the working capital cycle is being extended which invariably means cash generation will be delayed but in the meantime, the costs of creating that work in progress will quickly eat into cash that a practice has.
The ability to balance this will determine how well a practice deals with the bump in the road.
In addition to this, your clients will also be looking at that first quarter of 2021 and making plans of how to manage their own cashflow. No doubt you would have seen from the initial phase of the pandemic, a slowing down of cash collection, particularly for those firms that have commercial clients, as everyone wanted to preserve cash. This will happen again in the first quarter of 2021 and may, in fact, start to happen towards the end of the 2020 calendar year as businesses start to prepare for it. Using your creditors as part of helping you with your working capital cycle is a common practice for many businesses, but you do not want to be on the end of it!
What can you do? In order to try and smooth out the bump that is coming down the road, there are a number of actions you can take now and continue with throughout the next twelve months:-
1. Forecast, forecast and re-forecast.
Most practices have done short-term forecasting, such as the rolling thirteen-week forecasts already, to help them through the initial phase, which has been incredibly helpful. That newly formed habit (for some) must continue but must be pushed out on a rolling twelve-month basis. With life-changing so quickly, re-forecasting as a bare minimum on a quarterly basis is now required as more information comes to light.
2. Test your forecasts.
It is so difficult to predict what may happen in terms of activity levels across so many different areas of law during our way to recovery. However, you should always test your forecasts by applying a level of sensitivity. A good rule of thumb is a reduction of income of 20% to see what the impact is and therefore you can be ready to make decisions when you start to see this decline.
3. Carefully monitor people returning from the furlough scheme.
It is easy to say one is busy but the definition of busy has to meet the level of contributions an individual/team is making to the business. Un-furloughing a person too early who is not going to build up sufficient billing is going to be an expensive process. Un-furloughing too late and you may find that there is too much work for other people creating moral issue (which can be harder to detect when individuals are working more remotely), so it is a fine line to draw. This is where looking at daily/weekly chargeable time is an important management tool to gauge what action businesses should take.
4. Remain flexible.
Furlough has helped in the short-term but it will be coming to an end completely at the end of October. There have to be alternative measures, such as reduced working hours, pay cuts or a continuation of pay cuts, as many have happened already etc. This may apply across the whole firm or it may apply in different departments, the most important thing is to match activity level with demand so that you can manage the cost of producing the work in the most efficient way.
There is a famous phrase of “forewarned is forearmed”. This bump in the road is going to happen and it is better to be aware of it and plan for it as opposed to it becoming a sudden, unexpected surprise. There are many actions a firm can take to smooth this out, but those actions have to be looked at now with a plan put in place, but more importantly, have flexibility in that plan to change. If COVID-19 has taught us one thing, it is the ability to remain flexible at all time as things are changing considerably and the best practices are those that are prepared to change when required.
Do contact us if you would like more information about the way to recovery, or to talk about any aspect of law firm finance or strategic planning.