Best Practice: Law firm financial statements

Asked and Answered By John W. Olmstead, MBA, Ph.D, CMC Q. I was just elected by my other partners to serve as managing partner of our 17 attorney firm. We are based in Nashville, Tenn. I do not have an accounting background and I have questions about our financial statements:

1. Why does the income statement not reflect all disbursements for the month? For example it does not reflect partner draws, client advances, or payments on the firm line of credit?
2. I have only been receiving the income statement. Should I been receiving other financial statements?

A. Getting a handle on the financial aspects of your firm will be your most important role - whether you have a firm administrator or not. You should also be receiving a balance sheet which reflects the firm's financial position as of a particular point in time. The income statement only reflects income and expense accounts and reports net income for a reported period of time. The income statement is different that a statement of cash flows which reports cash flows during the period. Partner draws, client advances, and line of credit payments are not expense accounts (they are asset, liability, and capital accounts respectively).  Consequently, they will not be reported on the income statement. These accounts will be reported on the balance sheet. Other than reviewing the balance sheet for activity in accounts such as discussed above the balance sheet (without adjustment) has limited use. Its purpose is to reflect the firm's financial position as of a point in time. However, since most law firms maintain their books on a cash basis - the largest assets - accounts receivable and unbilled work in process - are not reflected. Accounts payable and other such liabilities are not reflected either. If you are interested in a true picture of the firm's financial position as of a point in time you must take these items into consideration. Another report that you may wish to receive is a statement of cash flows. This statement will report actual flows of all cash - in and out of the firm - regardless of account time. There are additional schedules and reports that you should receive as well. I suggest you review your system and create a report distribution policy as to which reports you and the other partners receive each month. Click here for our financial management topic blog Click here for articles on other topics John W. Olmstead, MBA, Ph.D, CMC, (www.olmsteadassoc.com) is a past chair and member of the ISBA Standing Committee on Law Office Management and Economics. For more information on law office management please direct questions to the ISBA listserver, which John and other committee members review, or view archived copies of The Bottom Line Newsletters. Contact John at jolmstead@olmsteadassoc.com.