Law Firm Accounting: What is in your Profit Statement?

What is financial accounting

What are we talking about in this article?

In order for a law practice to thrive and make practical, informed business decisions, it must have the necessary financial stability to keep it afloat. That starts with strong financial statements.

Law firms, like many businesses, both large and small, must keep track of their financial health to ensure they are performing optimally. Profit and loss statements, known as P&L statements, provide pivotal insight into cash flow, revenue, and profitability, no matter what the type or practice area.

What is a Profit & Loss statement, and what is it for?

A P&L statement is a document that shows a law firm’s revenue, expenses, gross profit, net profit, and other financial information during a given period of time.

This document serves as an income statement or cash flow statement, painting a clear picture of the law firm’s financial position at a specific time. The bottom line, or net income, shows whether the business is at a profit or loss based on their expenses and revenue during that period. 

If the firm’s profit exceeds its expenses, then its net income is positive. If the expenses exceed the profit, then the firm is operating at a loss, also known as being in the red.

Of course, law firms should always aim to have strong profit margins, with a profit over a loss. Through clear financial reports, these firms will know where they stand at a given time and can make better business decisions.

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Why is keeping financial statements so important?

Financial reporting is important for understanding the bigger picture in terms of cash flow and other business needs. There are also some more specific areas in which a P&L statement, along with other documentation, will prove useful. 

Lending

Small businesses often need loans, both when they’re starting out and when they encounter opportunities or challenges down the line, such as if they’re looking to expand. By preparing a P&L statement, a leader at a law firm can demonstrate their expectations and strength in terms of profitability and total expenses. 

This, in conjunction with tax returns and other financial statements, will help present a clear picture of your business needs and current situation. It will help lenders, whether banks, individuals, or other financial institutions, make informed business decisions as to whether or not they will give you that loan.

Cash flow and expense tracking

Any business leader knows how important it is to constantly know where you stand financially. When you maintain a profit and loss statement, you can clearly see how significantly — or insignificantly — your cash flow has changed in a given period of time. You’ll see the bigger picture of how your various activities are contributing to or detracting from your financial health.

Worst-case scenarios

There are also situations in which a P&L statement can help you weather a potential storm. For example, if you’re audited by the IRS at any point, you will need to show financial statements demonstrating your activities and how they have contributed to your current financial situations.

If you’re faced with a scenario in which you need to file for bankruptcy, your P&Ls will also prove essential in helping you navigate a potential crisis. 

How to increase profitability

Of course, profitability depends on the activities that contribute to your business. But there are financial decisions you can make that will help you not only stay afloat but thrive.

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Careful bookkeeping

Keeping careful track of your expenses and returns is an important step that will help you maintain your financial health. Bookkeeping isn’t just essential for your P&L statements — it’s also critical for your overall business. Many businesses hire professional bookkeepers to help them, while others use software like QuickBooks or custom tools and technologies dedicated to this purpose.

Categorizing profits and expenses

Part of properly maintaining financial records is categorizing your profits and expenses appropriately. The various categories will depend on your specific practice and practice areas, but some common themes are:

  • Employee salaries and additional expenses
  • Real estate
  • Marketing and promotions
  • Operating expenses
  • Travel 
  • Administrative expenses
  • Technology
  • Subscriptions
  • Contractors and outsourcing
  • Retainers
  • Client fees

 

A law firm will need to determine which categories are most important for its purposes and customize its financial documentation accordingly.

A tailored P&L statement

Likewise, it’s important to create a P&L that is specific to your individual law firm and business needs. Whether you work with a CPA and/or a bookkeeper or you rely on accounting software to maintain your records and create your documents, it’s important to tailor your profit and loss statement to the individual law practice, using the items that are most essential to your firm.

Tools that may help you: adapting to new technologies

So, how can you clearly see how your law firm is performing and ensure that you don’t land in the red zone unexpectedly? The good news is that there are plenty of tools and technologies available to help large and small firms manage their finances. Accounting software is one example, and there are additional means, methods, and tools that can assist you with a wide variety of profit and loss scenarios.

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Some of the main tasks technologies can assist you with or even perform for you are:

Customizable P&L templates

Gone are the days when you have to create profit and loss statements entirely by hand. Using accounting software and financial tools and technologies, business owners and leaders can quickly generate P&L statements that include all the pivotal information, as well as showing the bottom line. 

Simply by entering your firm’s information, such as your bank accounts, financial holdings, credit cards, expenses, and more, you can gain immediate insights and answer important questions about how you’re performing as a businesses.

Balance sheet templates

Balance sheets offer a bigger-picture view of your finances at any given point in time, such as monthly or quarterly. They will allow you to review what has happened at your law firm financially during that specific period. While they’re not the tools that will provide you with a bigger-picture overview of where your organization stands, they can help you get from point A to point B.

There are many technologies available to calculate balances and generate reports showing you where you stand at a point in time. There are also software-generated balance sheet templates that can assist you in this regard, too.

Dashboards with real-time analytics

These tools can also provide your law firm with real-time data and analytics about how you’re performing as a business. Dashboards synthesize a huge amount of data generated by your practice to present you with a clear picture of where you stand. You’ll also see what activities and contributes are generating a profit, where you’re showing a loss, and other critical insights about your business.

Dashboards ultimately offer actionable insights that will keep your business better informed, as well as show you possibilities on which you can act and directions for you to go in the future. You’ll learn how you can move as a business and correct mistakes going forward.

Data visualizations

Dashboards also typically offer data visualizations, with charts, graphs, and illustrations, that can help you better understand the information your law firm is generating. These analyses will also give you a clearer picture of how you’re doing in terms of profit and loss.

The legal industry is certainly one that requires careful financial monitoring at all times. Along with other financial tools and data, a profit and loss statement is a critical document that will assist you in navigating the financial landscape and monitoring your cash flow such that you’re able to be more informed and make better business decisions.

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