How to Analyze a Law Firm's Financial Statements

Our firm works exclusively with law firm clients and attorneys, and I've been privy to seeing many different spins on a law firm's chart of accounts.

I'm bringing this up at the beginning of this article because the chart of accounts is truly the foundation of how you analyze and interpret financial statements. The whole building can collapse if you don't have a good foundation. You want to have a good chart of accounts so that you're able to scrutinize the data at the end of the day.

Horror stories

When I first saw this new chart of accounts, my brain went right to this is for my landscaper and not a law firm. I have seen employee names on a chart of accounts, vendor names on the chart of accounts, and some pretty chaotic charts of accounts. Even worse, I've seen attorneys use the template and one from QuickBooks.

You should not see people’s names on a Chart of Accounts. And in QuickBooks Online, there should be only one account receivable.

There should be no inventory shrinkage on a law firm’s books. Soft costs for the expense side are just the expenses at the firm. IE, postage, copy expense, etc. And mileage should list under travel.

There's significant importance to structure your chart of accounts and how much detail. I've seen many people get finite in the details and not realize that some of what they are looking to track could be tracked by analyzing the vendor data.

We use a specific chart of accounts at our firm, and I share it here so that you have a good guideline or a basic structure to start. You can tweak it towards your practice area.

As you can see from the picture below, a good chart of accounts will help you set up a readable profit and loss report with a heavy leaning towards tracking metrics. Most clients want to look at that bottom line in our meetings. But the power behind these numbers is in the data analysis.

Remember, the profit and loss statement captures your income and expenses for a specific time set.

As you start to analyze your records, do you want to look at your net profitability and the profitability ratio? And for law firms, there's a specific percentage you want to guide your firm. Intuit provides a method for benchmarking these metrics against other firms that do the same work you do and are close to your office.

The three largest expense categories for law firms are as follows:

1. Salaries, wages, staff

2. Rent and office space overall

3. Insurance, depending on your practice area

What a Standard QuickBooks Profit and Loss (P&L) won't tell You

How much does this firm spend on wages, workers' comp insurance, employee benefits, vacation, and paid time off? Knowing each employee's costs is a key performance indicator (KPI) that all business owners should know. 

For example, what is the actual cost per employee at your firm? It's not as easy as looking at total wages. You must factor in pay time off, vacation, employer taxes, and Worker's Compensation.

Using the above calculation, check that against your gross revenue. Your employees and non-equity attorneys should only cost you 20 to 30% of the gross revenue.

Similarly, how much does this firm's office space cost them in total, including rent, utilities, janitorial, and visitor parking?

Seeing this data is somewhat hidden using the information presented in the sample P&L above.

Indeed, not only can't you answer the questions after a glance at the P&L. Sure, you could grab your calculator and a piece of paper and do the math. But a good accounting firm will help you as your business partner analyze this data.

Hand-in-hand we can create a fine-tuned, customized profit and loss that will benefit the firm and help the partners understand every metric they want to study and improve.

We can restructure your chart of accounts using parent in sub-level accounts to organize similar expenses into broad and understandable categories providing much more clarity to the business owners and your typical standard chart of accounts from QuickBooks.

It's imperative for the business owner to know the true cost of the overhead of running your firm. Armed with this data, you can make significant business decisions in the future to a profitable future. Having the right accounting team behind you will set you up for success!