Financial statements 101: A guide for lawyers
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Profit and loss statements |
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Balance sheets |
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Statement of cash flows |
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Why financial health insight is critical |
Most lawyers probably aren’t eager to dive into the financials of a small business. But if you are a solo attorney or practice at a small law firm, the financial component of running your operation is part of your life, whether you like it or not.
Luckily for you, no one expects you to be a CPA. Even so, a fundamental understanding of commonly used financial statements is nothing but helpful. It can inform some aspects of your practice — for instance, making discovery requests — and will 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 having to depend on outside help. This, in turn, will enable you to make smarter decisions about calculating operating expenses, generating revenue, making investments, and regulating cash flow.
Here’s a brief explanation of the most common financial statements your firm should use.
Profit and loss statements
As the name implies, a profit and loss statement (P&L) provides a record of the gross profit coming in from client billing, along with a tally of the firm’s expenses. A P&L may either provide a truncated overview of expenses or break them down further into parent and child categories. This provides insight, for instance, into what percentage of an employee expense is due to salary and which can be attributed to benefits.
Balance sheets
A balance sheet illustrates your firm’s worth by using a fairly simple 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.
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Statement of cash flows
Otherwise known as a cash flow statement, a statement of cash flows 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 while the other separates net income from operating expenses. Loan officers use this statement to assess the financial health and stability of your firm.
Why financial health insight is critical
Every transaction impacts the financial health of a law firm over time, and understanding how to decode financial statements can give you deeper insight into 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.
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