The other day I was assisting in an upgrade of accounting software at a client’s office. The managing partner came in and was clearly agitated. “Can you tell me,” he asked, “what an income statement is supposed to do? My accountant says it looks great. So how come I don’t have any money?” In order [...]
The other day I was assisting in an upgrade of accounting software at a client’s office. The managing partner came in and was clearly agitated. “Can you tell me,” he asked, “what an income statement is supposed to do? My accountant says it looks great. So how come I don’t have any money?”
In order to understand the answer to that question, it’s important to understand some important concepts: What an Income Statement represents; and what information it imparts to help the Managing Partner and/or Finance Committee make decisions to grow their law practice.
An Income Statement (also known as a Profit and Loss Statement, or Statement of Income and Expense) shows whether or not a law firm achieved or failed to achieve an important goal – that is, to earn a profit, or net income.
This financial statement lists all sources of revenue, and all of a firm’s expenses. It then subtracts expenses from revenue. If revenues are greater than expenses, then the firm has net income. If expenses are greater than revenue, the firm suffers a net loss.
The Income Statement also measures revenue and expenses for a set period of time, the maximum usually being one year. At the end of the year, any net profit or net loss is calculated and transferred. The entire report is “zeroed out” and it begins gathering revenues for a new year.
Because the Income Statement is periodically reset, revenue does not equal cash in the bank – this is a common mis-perception. Examples of revenue would be:
- Inflows received in exchange for services provided to clients
- Interest income
- Income from renting or subletting office space
- Inflows received from sources other than providing services
Expenses are defined as goods and services consumed in business operations. They include, but are not limited to:
- Office supplies
- Telephone expense
- Depending on how a firm views client-related costs, they may or may not be included in an Income Statement.
Knowing all this, what information can be gleaned from this report to help the Managing Partner(s) and/or Finance Committee of a firm?
- Be sure to look at the time period covered on an Income Statement. It is located at the top of the report. For example, if fee income equals $50,000.00, was that earned in one month? One quarter? One year?
- If client-related costs are included, and if they are listed separately from the amount recovered from reimbursements, is there a difference? Is there a big difference? Has the difference, or gap, significantly increased or decreased? Collecting or not collecting what was shelled out on behalf of a firm’s clients is one of the top reasons a firm financially succeeds or fails.
- There seems to be a common lament that it is difficult to find a way to track how much is collected by attorneys and other timekeepers. Breaking down fee income by timekeeper on an Income Statement makes it an excellent and reliable source for that information.
- An Income Statement can also include percentages of expenses in relation to revenue. Pay attention to those percentages! If, for example, a firm’s rent plus payroll exceeds 35% of every pre-tax dollar of revenue, how much is left over for things like equipment, the law library or projects promoting a firm’s growth?
By working with your accountant and/or financial advisor, your firm’s Income Statement can be an important source of information, advising members of financial strengths and weaknesses. Be sure to pay attention to it. After all, a firm’s bank certainly does.