Next year’s budget should be well underway — maybe for the nth iteration as forecasts are updated with each new low in the Dow.  Revenue forecasts will be particularly tricky this coming year.  63.5% of respondents in a recent survey indicated that they expect 2009 revenues to fall up to 10% from 2008 levels, with 2008 being a challenging revenue year for many firms as well.

Price increase is the single most significant factor to enhance revenue in most businesses.  Over two decades law firms have been able to raise billing rates at about 1.7 times the change in CPI.  This is down from a long term price increase average of nearly twice the CPI.  Not many businesses can claim a long term pricing pattern of this magnitude.  This year half of law firms surveyed are expecting only minimal and targeted increases in hourly rates.  And 14% hope to increase rates consistent with inflation.

Productivity in terms of average billable hours decline in a recession and an industry-wide 5% decline in 2009 could be a prospect worth considering.  Clearly some practices have contracted severely (securitized finance and real estate being prime examples), while others may hold up well (insolvency and regulatory come to mind).  While a modest decline does not sound serious, it really is very serious.  Those declines translate dollar for dollar into lower profits.

Pricing variances have increased from 2.5% to 4.7% over the past five years.  Meanwhile efficiency variances have held their own at about 7.5%.  We expect further pressure to discount rates and therefore higher pricing variances in 2009.  We further expect that clients will scrub your bills in greater detail, particularly with respect to staffing decisions.  The likely result will be increased downward pressure on realization.  And this will be on top of the more modest rate increases so the revenue affect will be more significant then it has been in the past.

Although law firms have not yet experienced a dramatic increase in the aging of their accounts receivable; anecdotal comments from corporations (your clients) indicate that they are more carefully managing their cash position, including stretching their accounts payable.  How quickly you turn over your receivables directly affects your working capital requirements.  Law firms have been particularly adverse to maintaining liquidity averaging about a half-week of free cash flow at year end.  The top quartile firms in terms of profitability however, average 1.7 weeks of free cash flow at year end placing them in a far more advantageous position to navigate these challenging times.

Budgeting this year should test the resiliency of your capital and profit profile against slower collections, more modest rate increases, a potentially slipping realization rate and varying challenges with respect to productivity.  Partners should be talking with key clients to understand their needs and expectations for the coming year — both in terms of the client’s business and industry environment and their legal needs.

This may be a good time to build up capital and liquidity.  Hopefully the credit markets will soon begin to function in a more orderly and rational fashion.  But until that time, law firms should be wary of the availability of credit, particularly on lines of credit that are far more vulnerable to being reduced or withdrawn on short notice.  Two means to improve liquidity include retaining earnings to raise your year-end free cash flow to two weeks from the aforementioned half-week norm.  The second approach might include additional debt to ensure its availability even if you only buy short-term treasury securities with the funds until they are needed.  Be mindful that if you raise debt that it still conforms to good financial leverage practices.

This entry was posted on Tuesday, November 25th, 2008 at 7:51 am and is filed under Economics. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.