Several top U.K. firms are operating with high levels of debt and little to no cash on their balance sheet putting them in a perilous position for the months ahead, according to an analysis by accountancy firm Smith & Williamson.

The preliminary figures, which will form part of the auditor's report with Legal Week on the state of the top 50 U.K. LLP accounts, show almost half had less than £10 million of cash on their balance sheet as of April 2019.

In addition, bank loans and overdrafts outsize cash positions at the majority of the top 50 firms, with only 12 firms operating with no debt at all.

The numbers make for grim reading at a time when transactional work has all but stopped due to the COVID-19 lockdown in the U.K. and beyond. Almost every top 50 U.K. firm has announced measures to help shore up finances, including delaying and cutting partner drawings, furloughing staff, freezing salaries and slashing pay.

Many of the firms with the low levels of cash and relatively high levels of debt argued either that the U.K. LLP accounts did not give an accurate view of the wider business, or that they had the ability to take on more debt if needed.

A separate analysis of the LLP accounts of the top 40 firms by litigation funder Augusta found that 55% had insufficient cash on their balance sheets to cover one month's operating expenses.

Herbert Smith Freehills and Clyde & Co have the highest amount of bank loans and overdrafts, the figures show. However, both firms also have high levels of cash.

Steve Bowers, HSF's financial director, said: "Our primary focus is on net debt rather than bank borrowings. We have significantly reduced our net debt by over 50%, part of our strong focus on financial discipline."

Giles Murphy, head of professional services at Smith & Williamson, said: "There are different ways to fund a law firm, some decide to fund with borrowings. If a firm has no debt, partners have to fund the firm. More debt can be positive for partners but the downside is that the firm can be at greater risk."

He added the industry has enjoyed several years of "benign trading conditions", which have not led firms to hold cash on their balance sheet. "There is always a tension within a firm – partners want to be paid," he said.

But the "unprecedented disruption to the legal space" this year means "firms with more cash are going to be in a much better position".

Of the firms with the least cash, three – Charles Russell Speechlys, Keoghs and Browne Jacobson – had no cash at all as of the end of the last financial year. And 13 firms had less than £2 million.

In addition to those firms with no cash, Freeths, Irwin Mitchell and TLT also had low levels of cash on their balance sheets – half a million pounds or less.

However, Irwin Mitchell pointed out that in its groupwide accounts, of which the LLP is part, its cash position was actually £6.2 million and that it had cash equivalent assets of £5 million. It added its position has also improved since the end of the last financial year and that it had ample room for manoeuvre within its rolling credit facility.

The firms in the most difficult position are likely to be the ones whose cash levels are very low as a proportion of their debt levels, according to accountants. Eight firms had a cash balance that was less than 10% the size of their debt.

In a statement, a Charles Russell spokesperson said the firm had invested in areas such as IT and that the firm expected to end the current financial year with a reduced net debt. They added: "The levels of loan borrowings in our balance sheet are not unusual for a firm of our size."

A Keoghs spokesperson added that, while its debt stood at £13.6 million at May 31, 2019, that was drawn from a committed facility of £25 million which did not expire until July 2021. The spokesperson said this left "a significant amount of headroom" to manage economic shocks or other downturns in trading.

When asked about its numbers, Freeths responded by saying it had used its bank funding in recent years to invest in the business through recruitment, IT and premises. It added: "We invariably operate comfortably within our agreed bank facilities and always maintain a high level of headroom to cover contingencies."

As of the end of March, Freeths' bank borrowing figure was £9.1 million while its fee income for the 12 months till then was £102.8 million, a 14.5% rise on the previous 12 months.

Withers has not yet reported its 2018-19 LLP accounts, but if it were included in these rankings based on its previous year's numbers it would have been in the top 10 by all three rankings. In a statement, a spokesperson for the firm said the U.K. LLP accounts covered only a portion of its business and "do not give a meaningful view of our global operations and how they are financed".

Staff costs

A fall in revenue combined with the need to service more debt is also problematic given wage bills have risen for almost every firm in recent years. In the last financial year lawyer and staff costs rose at 45 of the 50 firms, the analysis shows, and now stands at around 40% of total revenue for most firms.

Of the firms with a low cash-to-debt ratio, DWF has the highest annual staff cost, having paid out £126.4 million in the 2018-19 financial year, the analysis found.

A spokesperson for DWF pointed out that it had plenty of liquidity. In late April the listed firm agreed an extension of its revolving credit facilities, and announced an easing of requirements to allow it to take on more debt.

Irwin Mitchell was not far behind on staff costs, as it paid out £94.5 million in that year, according to the accounts, although the firm added in its groupwide accounts its staff costs were £103.2 million.

Meanwhile, Kennedys Law paid out £93 million and Charles Russell Speechlys paid out £73.1 million in staff costs.

The Augusta analysis found 38% of the top 40 firms had insufficient cash to cover one month's salary bill.

While wage bills have risen, Murphy at Smith & Williamson pointed out that the overall cash and debt position of top 50 firms had improved year-on-year. He said: "It was clearly moving in the right direction but a tsunami has hit this year."

Asked about the possibility of law firms defaulting on bank loans, Murphy said that banks are currently being supportive as they see the legal industry as a solid sector. "The default rate has historically been low."