All businesses, including law firms, use three reports to analyze their financial position – the balance sheet, the cash flow statement, and profit & loss (income) statement. 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.
The balance sheet shows all of the law firm’s assets and liabilities as well as the partners’ equity in the firm. It is called a balance sheet because the liabilities and equity should “balance” with the firm’s assets. 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 current assets than it does current liabilities, and should have an equal amount of debts (liabilities) and equity. The balance sheet allows partners to evaluate the firm’s liquidity (its ability to readily convert assets to cash) and allows them to determine if the firm is over-leveraged (has more debts than assets). 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.