Financial Management
Financial management in a law firm covers planning, monitoring, and controlling the firm's finances. Candidates must understand the three core statements: profit and loss (income and expenditure over a period), balance sheet (assets, liabilities, and equity at a point in time), and cash flow (movements in cash). Know the difference between profit and cash: a firm can be profitable and still fail for lack of cash. Understand working capital, the cash conversion cycle, and the levers: lock-up (work in progress plus debtors), utilisation, and realisation.
Key metrics include fee-earner utilisation, chargeable hours, average fee per matter, realised rate versus standard rate, debtor days, work-in-progress days, and gearing. Budgeting and variance analysis are essential: compare actual to budget, identify causes, and act. Know the concept of break-even and how fixed and variable costs behave.
Traps: treating revenue as cash; ignoring work in progress when assessing liquidity; confusing mark-up with margin; and overlooking the impact of partner drawings on cash. Questions may test how a change in debtor days affects cash, or how to calculate realised rate.
Worked example: a firm bills £1,000,000 but writes off £100,000 and collects £850,000. Realisation is 90% (900,000/1,000,000) and collection is 85% of billed. Combined, only £850,000 of cash arrives. Rule of thumb: protect cash first, profit second; lock-up is the enemy of both.