Financial Statements 101: A guide for lawyers
You went to law school to practice law, not to become an accountant. Nevertheless, it’s important to understand financial statements, especially if you are a solo or small law firm.
This knowledge can not only help you in some aspects of your practice — for instance, making discovery requests — but it will also make it easier for you to keep track of cash flow and receivables.
More importantly, you’ll know how to assess your firm’s financial health without needing to rely on second-hand information from your accountant. This, in turn, will let you make smarter decisions about calculating operating expenses, generating revenue, making investments, and regulating cash flow.
Without further ado, here’s a brief explanation of the most common financial statements your firm should use.
Profit and loss statement
As the name implies, a profit and loss statement provides a record of the gross profit coming in from client billing, along with a tally of the firm’s expenses. Profit and loss statements may either provide a truncated overview of expenses or break them down further into parent and child categories. This allows you to know, for instance, what percentage of an employee expense is due to salary and which can be attributed to benefits.
A balance sheet expresses your firm’s worth by using the following formula: assets = liabilities + shareholder equity. In other words, it provides a balance between the firm’s holdings, including real property, cash, and supplies, and the firm’s liabilities plus the capital shareholders have put into the company. The balance sheet allows you to determine to what extent you can meet both short and long-term debt obligations.
Statement of cash flows
Otherwise known as a cash flow statement, this document provides a record of all cash moving in and out of the firm, including operating activities, investment returns, and loans. It complements the balance sheet and income statement by providing a glance at financial activity within a shorter time frame.
There are two methods of calculating cash flow. One simply lists all cash receipts and payments; the other segregates net income from operating expenses. Loan officers use this statement to assess the financial health and stability of your firm.
Financial health insight is critical
Every transaction impacts the fiduciary health of a law firm over time, and understanding how to decode financial statements can give you important insights into how to predict the ebb and flow of revenues. Therefore, it’s essential that law firms use financial statements to maintain scrupulous accounting and tax records, preferably through an integrated software system that can be customized to meet the needs of your firm.
Learn more about the specific needs of solo and small law firms, by visiting FindLaw’s marketing resources section of our website today.