What is the purpose of a balance sheet?

Balance Sheet

All businesses, including law firms, use three reports to analyze their financial position – the [simple_tooltip content=’A statement of the assets, liabilities, and capital of a business or other organization at a particular point in time, detailing the balance of income and expenditure over the preceding period.’]balance sheet[/simple_tooltip], the [simple_tooltip content=’Financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.’]cash flow statement[/simple_tooltip], and [simple_tooltip content=’The profit and loss statement is a financial statement that summarizes the revenues, costs and expenses incurred during a specified period, usually a fiscal quarter or year.’]profit & loss (income) statement[/simple_tooltip].^[1]^[2] The purpose of the balance sheet is to capture the law firm’s financial position at a specific instance of time and is used to evaluate the firm’s financial health.^[2]

The balance sheet shows all of the law firm’s [simple_tooltip content=’An asset is any resource owned by the business. Anything tangible or intangible that can be owned or controlled to produce value and that is held by a company to produce positive economic value is an asset.’]assets[/simple_tooltip] and [simple_tooltip content=’A liability is defined as the future sacrifices of economic benefits that the entity is obliged to make to other entities as a result of past transactions or other past events.’]liabilities[/simple_tooltip] as well as the partners’ [simple_tooltip content=’Equity is the difference between the value of the assets and the value of the liabilities of something owned.’]equity[/simple_tooltip] in the firm. It is called a balance sheet because the liabilities and equity should “balance” with the firm’s assets.^[2] In other words, the assets and liabilities should add up to the exact same amount as the firm’s assets. A healthy firm should have more [simple_tooltip content=’Current assets represent all the assets of a company that are expected to be conveniently sold, consumed, utilized or exhausted through the standard business operations, which can lead to their conversion to a cash value over the next one year period.’]current assets[/simple_tooltip] than it does [simple_tooltip content=’Current liabilities are often understood as all liabilities of the business that are to be settled in cash within the fiscal year or the operating cycle of a given firm, whichever period is longer.’]current liabilities[/simple_tooltip], and should have an equal amount of debts (liabilities) and equity.^[2]^[3] The balance sheet allows partners to evaluate the firm’s [simple_tooltip content=’Liquidity is about how big the trade-off is between the speed of the sale and the price it can be sold for.’]liquidity[/simple_tooltip] (its ability to readily convert assets to cash) and allows them to determine if the firm is [simple_tooltip content=’A business is said to be overleveraged when it is carrying too much debt and is unable to pay interest payments from loans and other expenses.’]over-leveraged[/simple_tooltip] (has more debts than assets).^[3] It is a key tool that law firm managers and partners can use to figure out whether the firm is in or is heading toward financial problems.