Most small and solo law firms are working with financial statements that don’t give them the information they need to make informed business decisions. To illustrate what I mean, I’ve created a sample P&L for a law firm that looks like what I typically see.
Take a look at the profit and loss statement below, created for a hypothetical small litigation partnership. The financials use the standard QuickBooks expense categories — that is, the ones that are created when you set up your company file and let QuickBooks know you are a law firm. (Instructions about how to modify your chart of accounts are provided at the end of this article.)
What a Standard QuickBooks P&L Won’t Tell You
Using the P&L below, can you answer the following questions about the two largest expenses for law firms — occupancy and personnel expenses? (Download the PDF here.)
- All in, how much does this firm’s staff cost them?
- How much does it cost this firm to occupy their office space? (Include everything, including office parking, rent, etc.)
Unfortunately, you can’t answer those questions using the information in the sample P&L. Not only can’t you answer it with a quick glance at the expense portion of the statement, you won’t be able to answer it with a calculator and a scratch pad either. Why? Because the expense categories in this P&L are configured in a way that obfuscates that information.
In contrast, let’s take a look at another P&L — this one customized to provide a law firm’s principals with clear and meaningful information about its business. Now can you answer the questions? (Download the PDF of the customized law firm P&L here.)
The second example employs two simple strategies to organize the same data in a much more informative way:
- “Parent” accounts are created to organize similar expenses into broad and understandable categories.
- Insurance is divided into logical subcategories such as such as health and workers’ comp insurance (a personnel expense) and professional liability insurance.
These simple modifications to your accounting records are quick and easy, and they will give you a great deal of clarity, especially about the expenses your firm is incurring.
Guidelines to Help You Do This for Your Own Firm
Start thinking about the broad categories of expenses you want to track. Whether you are using QuickBooks or another accounting program, I suggest the following:
- Personnel expense. If you have staff — especially legal staff — you know that salaries are just one part of the true cost of being an employer. As you’re setting this up, think hard about all the other ways you spend money on human capital. Did you use a search firm or recruiting website (or even CraigsList) during your employee search? Are you paying benefits? All of these costs should be captured so that you can see the true cost of your staff.
- Occupancy expense. For most firms, this is the second-largest ongoing expense. Naturally, you’re going to place rent expense here, but don’t forget the other expenses you incur as a result of being in your particular space. Perhaps you have to pay the parking garage separately for employee parking, and for those pricey parking validation stickers. Do you have a janitorial service, a plant service, utilities? Include them. The rule of thumb is to ask yourself, would I still have this expense if I didn’t have this office?
- Advertising and promotion. This is probably the only line item that you’ll want to look at from a perspective of return on investment (ROI). Even if you’re not matching the precise income you’ve gained from each different advertising or promotional dollar you’ve spent, you’ll still want to look at this number closely. Subdivide this expense category in any way that makes sense to you. I have a client who has a sub-account called “Avvo” because he spends a lot of money on that service.
- Automobile expense. Most small and solo law firms pass at least some of their automobile costs through the business as a way to maximize allowable tax write-offs. The reason to use subcategories here is to split out parking expenses and tolls, which are deductible at 100 percent. This will help your CPA during tax prep.
- General and Administrative. This broad category captures all the costs you incur in the running of your business that cannot be neatly pigeonholed into one of the other categories.
Insist on Clarity in Financial Statements
Your P&L statement should be tailored to your specific business needs. Don’t let your accountant or bookkeeper use generic expense line items. Instead, insist on clarity and usability in your financial statements. If you can’t easily understand exactly what you’re spending, you need to revamp your books.
Extra: Click here to download PDF instructions on how to modify your QuickBooks chart of accounts.