The other day we were presenting a webinar (what else?) on “The Lawyer of the Future” to a firm’s summer associate class, now in the midst of their remote (what else?) June and July program, and the quite rational question came up, “What do associates need to know?”
Understand the context: We were talking about the business of law firms, and my most recent book, Tomorrowland, so they were not asking whether they should take Taxation 101 in law school or whether knowing how to run a deal or first-chair a trial would be a handy skill to have. They were asking, “Outside legal knowledge, what do we need to know?”
Here’s where I suspect many of you are anticipating that we would have headed straight to, “Technology” or “IT” or even “How to code.”
Understand: Technology is beyond great. That state of the art smartphone in your hip pocket has over 100,000 times more processing power than the computers that took Apollo 11 to the moon and back, over a million times more memory, and over seven million times more storage.
Technology has been a lifesaver (or at least a job-saver) for many of us in this new WFH world. But increasingly when people say lawyers need to know “how technology works,” I’m reminded of how automobiles were first introduced: Early car owners (they were all wealthy) needed a “chauffeur” not so much to drive the beast but to be on the spot to fix it when it inevitably and frequently broke down. Once cars became more reliable, owning a car did not require “knowing how it works.” You turned the key and off you went.
Now, our answer to the question: (1) How to read accounting statements and (2) becoming at least minimally conversant with basic statistics.
We start from the premise that law is a client service business. (And no, we’re not getting sucked into the debate over whether it isn’t really a “profession” instead. It’s both, OK? And here at Adam Smith, Esq., and in response to these summer associates, we focus on the business of law; we leave the “profession” part to professors at Harvard, Stanford, Columbia, Yale, and so on.)
“Client service,” in turn, has to be founded on understanding your client. One outcome from the pandemic is that client service will be more important than ever. Thus Accounting 101.
The fundamental accounting statements are critical tools in how your clients manage their businesses; if you don’t know how to read them (meaning read them for insight and good news/bad news) or are so haughty as to think them grubby and beneath you, you might want to rethink this whole BigLaw thing and switch course to the government or nonprofit worlds.
What are those “fundamental” statements? Two really, plus a third for extra credit:
- The income statement a/k/a revenue and expense a/k/a P&L: Where the money comes from, where it goes, what’s left as profit or loss.
- The balance sheet a/k/a assets and liabilities.
- (Optional) The statement of cash flows a/k/a sources and uses of funds, about which we’ll say no more.
Here are the two bedrock accounting statements “101” courtesy of Harvard Business Review.
The income statement
Also known as profit and loss (P&L) statements, income statements summarize all income and expenses over a given period, including the cumulative impact of revenue, gain, expense, and loss transactions. Income statements are often shared as quarterly and annual reports, showing financial trends and comparisons over time.
The purpose of an income statement is to show a company’s financial performance over a period. It tells the financial story of a business’s activities.
The balance sheet
A balance sheet is designed to communicate exactly how much a company or organization is worth—its so-called “book value.” The balance sheet achieves this by listing out and tallying up all of a company’s assets, liabilities, and owners’ equity as of a particular date.
The information found in a balance sheet will most often be organized according to the following equation:
Assets = Liabilities + Owners’ Equity
A balance sheet should always balance. Assets must always equal liabilities plus owners’ equity.
If a balance sheet doesn’t balance, it’s likely the document was prepared incorrectly.
Your goal is not to become a forensic sleuth capable of pulling the covers off, say, Enron or Wirecard. It’s to be able to hold a conversation with your client that refers to financial results with some degree of confidence.
That’s all we’re going to say about Accounting 101. What about Statistics 101?