Law firm financial statements: Four items you must review monthly

You probably didn’t launch your law firm because you have a passion for financial reporting.

Running a successful law practice takes dedication, focus, and a great deal of your time. So at the end of a long day, the last thing firm partners want to do is pore over detailed financial statements and analysis. Law may be your true passion, but it’s also critical to have a working understanding of your firm’s financial health at all times.

The key to maintaining a current and complete view of your firm’s financial position is to review monthly financial statements. These include the balance sheet, profit and loss (P&L) report, and income and cash flow statements. Packed with business intelligence and key financial insights, these reports help you better assess business sustainability and risk. They identify potential issues ahead of time—such as cash shortfalls, delinquent accounts, and unnecessary expenses.

Committing to review financial statements each month is essential to best understand current assets and liabilities, cash inflow and outflow, profitability, year-end outcomes, and potential tax burdens. While this sounds like a lot, keeping up with financial statement review doesn’t have to take up a great deal of your time. That’s why we created this concise list of must-review items that will keep you in the know about your firm’s financial health.

Four things to watch in your law firm’s financial report

Law firm accounting and bookkeeping expert Lynda Artesani, owner of Artesani Bookkeeping, deeply understands the importance of reviewing monthly financial statements for requisite information. Consider the following:

1. Accounts receivable

According to Artesani, “Accounts receivable is the number one item that firm owners should review first.” Accounts receivable (AR) statements provide a clear picture of accounts that are overdue, which essentially equates to money left on the table. Be sure to scan your financial statement for delinquent accounts that are 30, 60, or 90 days past due, for example.

“When we have a new client come to us, it’s fairly common to find several accounts that are 90 days past due. This is the first issue we attack to help bring accounts up to date for the client and put cash back into the business,” Artesani advises.

The goal is to ensure that all clients are paying on time, and it’s important to put a collection plan in place for those who slip past even the 30-day mark. It can often be astonishing to see just how much cash is missing from the bottom line after calculating past due accounts.

Artesani provides excellent advice to correct the common issue of outstanding invoices: “Use your technology to set up an automated process to remind clients about past-due bills. In QuickBooks, you can easily set up the reminder email feature within workflows. The system allows you to schedule a series of emails that launch automatically. If someone doesn’t read the first email and the invoice remains unpaid, at a scheduled date the next message will go out.”

Beyond automated reminder emails, Artesani also recommends that firm leaders take the time to thoroughly evaluate existing internal AR workflow, then implement improvements. “A lot of times firms have multiple people handling AR and they don’t have a smooth workflow. Partners need to ensure the process is efficient and everyone is processing work in the same way so that nothing falls through the cracks.”

2. Payroll

Payroll is typically a firm’s single biggest expense. As such, it’s critical to review this information regularly to identify and analyze issues such as overtime and new hire needs. If a firm is in a state of growth, this information proves invaluable for evaluating staffing needs and assessing benefit requirements. For example, it might make sense to consider bundling HR services with a retirement plan and health benefits in a lower-cost package as your firm grows.

”For a firm that’s in a growth stage, we would look at payroll data carefully and evaluate the need to bring on new staff. For example, if there’s a lot of overtime, does it make more sense to hire a part-time person instead of paying the overtime? Or does it make sense to move up to a group benefit plan where HR is included, taking the onus of HR compliance off the firm and lowering costs? Evaluating payroll is one of the best ways to better control expenses,” Artesani explains.

3. Marketing expenses

In Artesani’s experience, marketing is typically one of the larger expenses that shows up on a financial statement. Like any business, growth is a key objective. Marketing is part of the formula to help accelerate financial success and is a necessary operating expense for most law firms. Artesani explains: “Firms tend to just throw large amounts of money at marketing and then assume it’s working. That’s not always the case, so they really need to look more closely at this expense and compare it against results.”

Marketing is not a set-it-and-forget-it effort. Firms must measure results to ensure proper return on investment. Artesani helps her clients automate this process.

“Using QuickBooks, you can create a custom field on the invoice that will capture the lead source. This data flows back into QuickBooks so when you onboard the client, it shows how they heard of the firm, for example, from a marketing campaign or online ad. Now you have data that connects the lead source with the dollar amount of the client account so you can intelligently evaluate if marketing efforts are working.”

4. Realization rate

This information ties back to AR, offering insight into money that is actually collected. Firms have long adhered to the billable-hour pricing method with the assumption that hours billed equal cash inflow. In reality, after reviewing financial statements, realization rates are often lower than expected because of overdue or delinquent invoices. This can be an eye-opener for partners and a big motivator to transition to a value-pricing method.

Based on years of experience working with law firms, Artesani cautions, “Typically, when we really dig into realization rates, often we find it’s only about a third of what the firm billed has actually been collected.”

This point alone is a strong incentive to get out of what Artesani calls “time mode”:

“The goal is to move firms away from billable hours and get them to adopt a subscription model. They can make so much more money this way.” She adds “If you look at the Clio 2020 Legal Trends Report under realization rate, stats show that, on average, attorneys only bill 2.5 hours of a typical 12.5 hour day.”

Final thoughts…

While not an exhaustive list, this guide provides law firms with sound advice and insights into what to look for in their financial statements. Reviewing this key information each month gives partners and lead executives critical knowledge about their firm’s financial health, sustainability, and potential future risks.

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