How Should Law Firms Track Finances?

There are two basic methods for keeping track of law firm financial performance:  accrual and cash accounting.  Accrual records income irrespective of whether cash has been collected, and reflects billings, work in progress (completed but not yet billed) and accounts receivable (work billed but not yet collected).  Cash accounting, on the other hand, reflects only collections, never billings or work in progress.

Larger law firms maintain both cash and accrual records.  Income statements, also called profit and loss or P&L statements, track financial performance in a given time period, using the accrual method to tell how much revenue has been billed, how much expense has been accrued, and how much net income or profit resulted. 

Almost all small law firms operate on a cash basis, accounting for cash as it comes in and goes out. Income or profit figures generally has little relevance to small law firms.  Small professional service firms typically operate on a cash basis, with the lawyer’s salary or draw coming from positive cash flow as the largest variable expense.  This reflects the lawyer’s personal needs and style of living, and the most sensible practice is to increase it only as the firm’s performance produces sufficient income on a regular basis to do so.  Amounts set aside for savings and retirement should be approached similarly to salary.  Keeping the draw to a minimum figure allows the firm to operate within its means, retaining sufficient cash for periodic valleys. At the end of the year, bonuses for good performance of the firm can be distributed. It’s safer, however, even at the end of the year to retain sufficient cash to take care of unexpected dips in revenue or increases in expenses.

Within these parameters, any attorney can do a personal P&L statement to document individual financial performance.  The calculation is a basic one:  Billings – [Total Compensation + Direct and Indirect Expenses] = Net Profit. 

Categorized in: Cash Flow - Finances