The Importance of Numbers: Why Attorneys Should Care About Accounting

by Edward Poll, J.D., M.B.A., CMC

When setting goals, it is important to be specific and also have a way to measure whether you have reached your goal. In many instances, this requires the use of accounting ... our article this month highlights some of the basic terms used in accounting. See below.

Accounting is a world of numbers -- financial numbers. For a law office, accounting means keeping track of money flowing in and out of the practice, an activity attorneys seem to have little time for. But the importance of proper accounting procedures -- it's required for client trust record-keeping -- cannot be overstated. An understanding of basic accounting can positively impact the internal operation of your firm and allow you to:

• Design and request the management reports that are important to you and that will help you manage and operate your practice more efficiently and more effectively;

• Understand, question and utilize financial reports and information presented to you; and

• Make changes in your future course based on an accurate interpretation of the reports and financial information.

Outside of the firm, accounting continues to help the lawyer by allowing you to:

• Speak the language of business, which is essential if you're seeking corporate clients;

• Understand and empathize with corporate or individual clients when they complain that business is slow or that the cost of doing business is rising, etc.; and

• Examine or cross-examine documents and experts where financial information is significant to the successful pursuit of your client's matter or litigation.

An Accounting Glossary

Like any other profession, the world of accounting has its own language, and a knowledge of key financial terms will be valuable for any lawyer involved with financial matters.

CASH vs. ACCRUAL ACCOUNTING: Cash-basis accounting reflects only the collection of cash into the practice, not billings or work in progress (work not yet billed). Keeping track of cash coming in or going out is the basis of most small-firm finances. Accrual-basis accounting reflects income from billings (as contrasted to collections).

ACCOUNTS RECEIVABLE: Money that is owed for work performed and billed but not yet collected or received.

ACCOUNTS PAYABLE: Money (usually expenses) that is owed others and not yet paid out.

AGING: An analysis of how old billings and accounts receivable are.

INCOME & PROFITS: These are accrual accounting terms both referring to what is left over after expenses have been deducted from sales or revenues. Of little relevance to small firms using cash-basis accounting.

REVENUE: All the sources of cash to the firm including fees, awards, recoveries, etc.

EXPENSES: Costs of operations including salaries, rent, supplies, insurance, etc.

Accounting Reports

Accounting and management reports that you prepare, or have prepared for you, can be critical to your firm's growth and success. Accounting reports that summarize the results of business transactions during a specific period of time are usually called [ITALIC] financial statements [NORMAL], and are the first three explained below.

CASH FLOW PROJECTION: This is the most important report available to a law firm (or any small business). Cash flow projections are usually in the form of a spreadsheet with months (12 to 18) listed across the top and expense and revenue items listed to the left from top to bottom. (There are two separate sections: revenues and expenses) The amounts of money collected and spent by the month should be inserted into each grid "cell" with totals for the month and for the year computed. Cash flow reports are usually created annually and updated each month as more information is learned.

(For an actual cash flow projection form, see the author's book "Attorney & Law Firm Guide to the Business of Law^®: Planning & Operating for Survival & Growth" published by the American Bar Association, 1994.

A monthly variance report can be created separately or included as columns in the cash flow projection. This highlights all the major changes from the projection compared to the actual amounts paid and received.

A daily cash report can also be used, where the previous balance is modified by the change in the day's cash position (cash in minus payments mailed out).

INCOME STATEMENT: This is also called the "profit and loss" statement, or "P&L," and is used to chart the figures used in accrual accounting. As such, it is not that important for cash-based law firms, although it does give an overview of the relative financial health of the business. Income statements are typically prepared on a quarterly or annual basis.

BALANCE SHEET: The least important report for a professional service business, a balance sheet is a snapshot of a firm on a certain date. It lists all assets and liabilities.

ACCOUNTS RECEIVABLE SCHEDULE: This monthly report shows how much money is owed by each client.

ACCOUNTS RECEIVABLE AGING: Prepared monthly with weekly updates, the "aging" shows how much money is owed by each client and the month in which the bill was sent or how many months the bill is outstanding. This is an essential document for the effective practice of law.

ACCOUNTS PAYABLE AGING: Similar to the receivable aging, the payable aging is a monthly expense report that tells you how much is owed to whom and for how long. Based on your cash availability, you can use this report to pay your bills.

WRITE-OFFS: A monthly report that tells you how much billing you have eliminated. There are two basic types of write-offs: time that never gets billed because you do not want to charge for it and money previously billed but "written off" in response to a client's complaint or a negotiated resolution because of a billing disagreement.

HOURS WORKED: A regular report that compares hours worked and billed with the total hours that you set for your billing goal for the day, week or month.

Accounting Support

While many lawyers and law firms will use the help of outside accountants or bookkeepers, the fact remains that you still need to be familiar with the information if you are going to learn from it. And one form of accounting help that has become invaluable to law offices, no matter who is doing the actual work, is computer software. There are many software programs that can help you prepare the reports mentioned above. Some of the most popular today include: Excel, Quattro Pro and Lotus, which are all spreadsheet programs. But don't forget word processing programs like WordPerfect, which are very powerful and now offer some of spreadsheet and database functions that are essential to accounting.

A special mention should also be made about Quicken, the number-one selling financial information software on the market. This relatively inexpensive program is easy to learn and capable of not only producing many reports, but it can also write your checks, maintain your check register, develop budgets and keep track of more than one bank account.

The technology exists to make your or your staff's life easier and to keep you better informed. So even if you're using an outside account or bookkeeper, you still can take information and generate reports internally. Also, since almost no accountants now work only with pencil and ledger, providing an accountant with information on computer disk will shorten their effort -- and reduce their fee -- since they can simply plug it into their automated system.

Understanding and working with financial information is the goal of accounting. Lawyers who spend the time and energy to improve their accounting skills can only profit from analyzing financial information to help guide the growth of their law practices. Understanding financial figures, learning the language of business and using accounting and management reports permit you to focus quickly on the financial side of your practice and delegate routine tasks to staff or outside contractors while you practice law, market your services and address only those areas in your firm that need adjusting to be even more efficient and more effective.