Spotting the danger signs: how robust is your firm?

Financial matters are not always front of mind for partners and directors whose interests are typically more invested in the core activities of the business and delivering for clients. However, without accurate and up-to-date information on their cash position, some professional services firms might not recognise just how close they might be to going bust.

So, what are the warning signs to look out for? 

Loans to finance short term requirements

Where firms take on short-term debt to finance salaries, property rents or VAT payments, the signs can point to lack of financial control. The more debt that is taken on, the more expensive it becomes to service.

Working capital shortfall/ lock up

If a firm has substantially more cash tied up in lock up than its competitors, alarm bells should ring. One management team came to RSM for help when it needed to put £33,000 a day into the business just to keep it going.

Run-away property costs

Property costs average 13 per cent of turnover in professional services firms. If costs are greater than 15 per cent, then a potential problem is brewing. At 20 per cent of turnover this indicates a serious issue and a property portfolio that is too expensive to run.

Less money in than out

Keep an eye on the ‘make-take’ ratio. If the ratio of what the business makes, versus the amount that the partners/directors take out is less than one for three consecutive years, then the sources of underperformance need to be rooted out.

Other red flags include a declining credit score; county court judgments; year-end adjustments between management and statutory accounts and failure to meet budgeting targets. 

Avoiding the big bang

Owning up to financial problems is the first step to getting back on track, but should not be underestimated. The next is management information that gives a true perspective of the overall financial status of the business.

Performance management tends to be one of the areas where professional services firms, which essentially sell people’s time and intellect, are poor. Where management information points to underperformance by key personnel, it may be a case of letting them go so the business can thrive, difficult as that may be.

Keep external stakeholders, including debt providers, on side and informed. A business that recognises that it is struggling and goes to its lender with analysis and solutions, is more likely to be seen as able to regain control.

Other remedies include limiting the number of people who can commit the firm to spending; putting together short-term cash forecasts; resolving disputes on outstanding debts and outlining a potential response to an economic downturn. A firm that sought help from RSM to improve its credit score found that relatively simple changes led to an enhanced credit score which increased its chances when tendering for work.

Addressing the warning signs is largely about changes in behaviour – understanding that cash is important and that without effective financial management, take-home pay and the business will suffer.

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Top 10 red flags professional services firms can act on immediately