Understanding Financial Statements for Law Firms

This is a guest post by law firm financial expert Brandy Derrick of Legal Ease Bookkeeping. 

Every career has its own set of lingo, special terms, and years of learning to master.  Attorneys work very hard to become skilled in their field, mastering enormous amounts of knowledge, terminology, and concepts.  Although busy with his or her practice, an attorney would do well to learn the basic terms of the financial statements.  Understanding each one will help an attorney profit and make adjustments in business.

The Balance Sheet lets the attorney know how much the business is worth at any given time.  It lists all his or her ownings, debts, and share in the company.  The first section of the Balance Sheet shows how much money was in the bank when the report was created (usually at month end).  These numbers can be found on the bank statements, as well.  

The next section shows the valuable equipment and buildings that the business owns, such as vehicles, computers, etc.  If the business books are kept on accrual basis, the report will also show how much money is owed to the firm (Accounts Receivable).  All these items together – the bank balances, equipment values, and income expected – make up the assets of the business.

The next section is not so pleasant – the Liabilities – also known as the debt of the firm.  Any money owed to companies will be listed at the top (accounts payable), then the credit card balances, and lastly loans.  Each month these numbers need to be updated so that the company knows exactly how much is owed on each item.

Lastly on the Balance Sheet, the attorney can see her equity in the business.  Any money she personally invested or withdrew will be listed here.  The remaining balance will be what she would receive if the business were to be sold.  Once all the debt is paid off, whatever is left of the assets’ values would be what the attorney would get to keep.  Careful management of the company can help keep the equity in a positive place.  Of course, if the law office is owned by partners, each partner will have an appropriate share in the equity as well.

The next report is the one most attorneys will take the time to read, because it tells them how the business did that month in the profit and loss arena.  Most people simply call this report the Profit and Loss report, although it is formally called the Income Statement.  Either way, it is beneficial to look carefully through the income and expenses generated each month.

First on the Income Statement, and hopefully the largest numbers, is the income earned.  If the books are being recorded on a cash basis, the report shows the income received that month.  If using Accrual, the income shown is really the money that was earned that month.  Some or all the money may not even be due to the attorney, so it is important to know how the report was created.  The income can be broken down by client and compared with previous Income Statements if desired.   

Expenses are shown next, broken down by category such as auto, rent, meals, office, and so on.  Payroll expenses will normally be the highest expense in a business.  The best way to decide if the expenses are extra high is to compare them with previous months, or even the same month a year ago.  Good steady numbers help the firm to know what to expect and how much money to keep ready for each month.  The Income Statement will not show any personal expenses that the owner or employees may have spent during the month.  This report is strictly to show what it cost the business to operate.

The money on the income side before expenses is called the Gross Income.  This number helps an attorney to know how much money his business can make, and whether he needs to attempt to gain more clients or hire more employees to handle the load.  Whatever remains of the income after expenses go out is Net Income.

Finally, most bookkeeping reports include The Statement of Cash Flows.  This report is probably the most confusing of the three, but it is important.  The flow of money into and out of the business is outlined in this report.  All operating activity, including income, credit card payments, tax payments, and money owed will be listed first.  The sum of these operating activities shows the Net income plus or minus the operating activity.  

The next section shows whether any financing activity took place, such as a new loan, payments on a current loan, an owner investment, or an owner taking a draw from the company.  The final figures here show whether these activities increased or decreased the net cash.

And lastly, at the end of the report, the Beginning and Ending Cash numbers are listed.  If the Cash at the end of the period is a higher number than the beginning cash, the month was probably good.  However, this is why one must understand the entire report.  The ending cash balance may be good because of a new loan.  

All three reports should be reviewed and carefully studied each month so that a clear picture of the firm’s financial month can be understood.  It is better to adjust expenses or work at gaining a little more income throughout the year, than to find out only at tax time that the company is not even making a profit.

Careful attorneys want to know at all times how their office is succeeding, and will enjoy a successful practice if they read and understand the financial reports often.

To get expert financial advice for your firm, contact Legal Ease Bookkeeping.