How do I read my law firm’s balance sheet?
The balance sheet provides a crucial tool in understanding your firm’s financial health at a glance and determine its current value. Many accounting programs can easily produce this report for you. Not only can this help guide decisions, but you may also need to present this information in order to obtain a loan.
The balance sheet follows a straightforward formula: Assets = Liabilities + Shareholders’ Equity[1]
In the formula, the following definitions apply:
- Assets: everything the firm owns, including cash, buildings, computer equipment, and supplies.
- Liabilities: financial obligations the firm has, such as loans or accounts payable.
- Shareholders’ Equity: the capital partners of the firm have put it in.
The following formulas can help you use the numbers show on your balance sheet to evaluate your firm’s ability to cover its debt, stay profitable and be successful.
To see if your firm can pay its debts and be able to have funds in the event of a short-term emergency, look at working capital = current assets – current liabilities[2].
To see if your firm is having collection issues, look at your accounts receivable. Compare this over time to your overall sales. If your accounts receivable is increasing at a rate higher than that of sales, you may have a collections problem.
To see if your firm is able to pay off its short-term debt, look at the current ratio (current assets ÷ current liabilities). If the number is close to 1 or under, you may be spending more than you cover[3]
References
1. Accounting 101 for Solo, Small and Mid-size Firms
2. Formulas and Calculations for Analyzing a Balance Sheet
3. Business Literacy: Current Ratio