Sunday, 19 May 2013

Show me the money - lawyers and financial awareness

An amateur astronomer with a decent telescope can, on a moonless night, gaze towards the heavens and just make out the faint green glow of the mysterious world where our arch-enemies, the accountants, are born (or perhaps grown in pods) and trained - Planet Finance. A world where “prose” is unknown and the inhabitants spend their school years poring over pages filled entirely with numbers. A world in which the preamble to the Declaration of Independence begins not with the words “We hold these truths to be self evident …” but with an Excel pivot table showing a sensitivity analysis of benefits and risks. Sounds hideous, doesn’t it? But, if you’re a lawyer, I'll wager this vision resonates with some of your prejudices.

Back on Planet Earth, we need to talk about finance and lawyers. I’ve written previously about metrics and said that finance is the language of senior management. More recently, I’ve taken part in several round-table discussions about the importance of financial fluency with groups of lawyers and concluded that there are vastly different levels of financial proficiency in our profession. Many senior in-house lawyers are extremely strong on financial skills and many take the requirement as a given. But I don’t think the importance of building these skills has been as extensively communicated as it needs to be.

Let’s start with a few questions. If you’re an in-house lawyer, think about the business or division you sit in. If you’re a private practice lawyer, think about your favourite client.

First, some financial questions. What were the revenues of the business you have in your mind during the last financial year? What was its operating margin? By how many basis points did the margin increase or decrease during that year? How is it tracking this year? What’s the cash flow like? Do you know what the DSO is and whether it has shortened or lengthened? If you are thinking about a parent company, what’s the net debt at the moment and what’s the cost of capital? If the company is publicly traded on a stock market, what multiple is the stock trading at? And for each of these numbers, what do you infer from them?

At the risk of alienating some readers, these questions really are just the most elementary. If you find them off-putting, let me ask some non-financial questions. Do your colleagues spend large amounts of time in meetings scrutinising tables of numbers? Do you attend these meetings? When presented with a page consisting only of numbers, do you glaze over and let others read and comment on them or do you get involved? Do you find your CEO and the other business leaders very engaged in reading numbers, even that they start with the numbers before turning to other things? If you don’t like numbers but answered “yes” to any of these questions, are you curious to find out why they like numbers so much?

Most lawyers can take a long document, such as a contract, and very quickly extract key information from it. Most are so proficient at doing so that colleagues are amazed when they see it. Lawyers quickly scan documents to find relevant information. In the case of a commercial contract, they will rapidly locate and read termination clauses, provisions on limitations of liability and key milestones. The reason they're so good at this is pattern-recognition. They recognise what looks normal and they have a sense for where to find useful information and when things don't look right. Too often these same smart lawyers are befuddled by numbers. Presented with two pages of numerical tables, many lawyers that can easily fillet an 80 page document in minutes are rendered blind.

This is something we have to fix. In any well-run business, everyone sitting around the Board table and on the senior executive team, whatever their role, is going to have a firm grasp on the core numbers of their business. Think of it a little like sport. You win matches by hiring great players, turning them into a team and getting a winning game-plan together. But the outcome of every game is a score and, across a season, a set of scores. If you don’t understand the scoring system, you can’t really understand the game.

If you want to be influential within a business or with your corporate clients, or even if you just want to ensure that what you’re working on actually matters to that business, you have to understand its numbers. I’m not going to spend a lot of time setting out what I think the minimum requirements are, because that will depend on your role and on the business in question. But, in terms of the P&L, I’d expect internal or external lawyers to understand (working from the top): Order Intake, Revenues, Contribution Margin, Operating Profit and beyond that Cash.

These things may seem abstract, so perhaps it’s easier to describe the journey down the P&L in a more tangible way. Every business, whatever the product or service, is dependent on its “Inquiry (or Lead) to Cash (or Remittance)” cycle. Let’s take a business we can all readily understand, a law firm. If I ring up a law firm and enquire about instructing someone, that’s the beginning of a process which flows through me receiving a service (legal advice), being sent a bill (which triggers revenue) and finally paying that bill. Until the law firm has the cash from me, the process hasn’t concluded. And understanding the cash position of any business is important, because failure to convert revenue into cash explains how a business whose revenues are growing can go bust. As the saying goes, accounting is opinion, cash is fact.

If you’re a lawyer spending a company’s money on legal fees or sending bills to a client, understanding the operating margin is a matter of basic respect for your colleagues or the client. If the margin is 20%, then every $1,000 you spend on legal fees requires $5,000 of sales to pay for it. And if the margins are slimmer, perhaps 5%, then it will take $20,000 of sales to pay that legal bill. You can see why the CFO quickly gets agitated about professional fees.

So how can each of us go about improving our financial fluency? I think there are two steps any of us can take. The first is to take some kind of formal training. There are plenty of providers out there, but if you can, take one of the five day courses as a minimum and don't choose one aimed at lawyers. The second is to practise. You may find your role doesn't require you to read numbers every day. If so, make a friend in Finance or ask your boss to share pages of numbers with you and then ask him or her to force you to read them and describe the key conclusions you draw from each page. If you practise, you'll soon start to see patterns and, before long, standard pages of numbers will be no more daunting than that 80 page contract.