Attorneys often encounter financial documents in litigation, transactions, or due diligence, yet many lack formal training in accounting. “Financial Literacy 101: What Lawyers Need to Know,” presented by attorney Alex Henlin of MGC Law and forensic accountant Brian McDonough of PKF O’Connor Davies, bridges that gap. This course introduces essential financial concepts to help lawyers confidently interpret financial statements and collaborate effectively with financial experts.

Why Should Lawyers Understand Financial Statements?

Lawyers regularly deal with cases where understanding the numbers matters. Whether it’s a valuation dispute in a divorce, a business interruption claim, or financial due diligence in a merger, a lack of financial literacy can put attorneys at a disadvantage.

Consider these scenarios:

• A family law dispute involving the valuation of a closely held business
  
• An insurance claim requiring business interruption loss calculations
  
• A litigation involving suspected financial misrepresentation
  
• A bankruptcy where working capital and cash flow determine viability
  

Financial statements are the language of business—and lawyers must be able to read them.

What Are the Core Financial Statements?

Understanding financial statements starts with knowing the key documents and what they show.

The Four Main Financial Statements:

1. Balance Sheet: A snapshot of assets, liabilities, and equity at a specific point in time
   
2. Income Statement (Profit & Loss): A summary of revenues and expenses over a period
   
3. Statement of Cash Flows: Tracks inflows and outflows of cash, divided into operating, investing, and financing activities
   
4. Statement of Shareholders’ Equity: Shows changes in ownership interest, including stock issuance, dividends, and retained earnings

Don't Overlook the Footnotes:

• Provide essential context and disclosures
  
• Explain related party transactions, debt terms, contingencies, and more
  
• May contain critical insights not visible in the core statements
  

How Do Accrual and Cash Accounting Differ?

Most financial statements are prepared using the accrual basis, which matches revenue and expenses to the period in which they are earned or incurred—not when cash changes hands.

In contrast, cash basis accounting records revenue when received and expenses when paid. Lawyers must understand which basis is used, especially when comparing tax returns (which may be cash-based) to financial statements (typically accrual-based).

For example:

• Accrual: A service provided in December but paid in January is recorded as December revenue.
  
• Cash: That same service is recorded in January when the money is received.

Key Accounting Concepts Every Lawyer Should Know

Understanding a few technical elements can make a big difference when reviewing or litigating financial issues.

Common Accounting Estimates and Adjustments:

• Allowance for Doubtful Accounts: Reduces accounts receivable to reflect expected uncollectibility
  
• Inventory Valuation: Recorded at the lower of cost or market; often adjusted when products become obsolete
  
• Depreciation: Allocates the cost of assets like equipment over their useful life
  
• Contingent Liabilities: Must be recorded or disclosed based on probability and ability to estimate losses (e.g., pending litigation)

These entries require management judgment—and are vulnerable to manipulation. Attorneys should be alert to red flags like overly optimistic revenue recognition or understated liabilities.

How Can Lawyers Effectively Use Accounting Experts?

Accounting professionals can play vital roles in litigation, transactions, and investigations. Their insights help uncover hidden assets, assess valuations, and analyze trends.

Ways Accounting Experts Support Legal Cases:

• Uncover financial misstatements or fraud
  
• Provide valuations for divorce, probate, or corporate disputes
  
• Assist with due diligence during business transactions
  
• Evaluate the financial impact of business interruptions
  
• Serve as testifying experts under Rule 702 (or state equivalents)
  

When retaining an expert, ensure their opinion:

• Is based on sufficient data
  
• Applies reliable principles and methods
  
• Is tailored to the facts of the case

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What Are the Different Types of Financial Reports?

The level of assurance offered in a financial report can vary, depending on whether it's an audit, review, or compilation.

Types of Financial Reports:

• Audit: Offers reasonable assurance that the financials are free of material misstatement. May include an “unqualified” (clean) opinion or other types like “qualified” or “adverse.”
  
• Review: Provides limited assurance based on inquiry and analytics—less in-depth than an audit.
  
• Compilation: Offers no assurance. The CPA helps prepare financials based on client-provided data, without verification.

Attorneys should read the auditor’s report carefully—it reveals what was examined, under what standards, and any concerns the auditor raised.

What Should You Ask for in Discovery?

When financial issues are central to your case, tailor your discovery accordingly. Financial documents can unlock critical information when used effectively.

Discovery Requests Might Include:

• All financial statements and accompanying footnotes
  
• Tax returns for comparison against reported income
  
• Trial balances and general ledgers for detail-level data
  
• Documents related to contingent liabilities (e.g., legal letters from auditors)
  
• Information on internal controls (especially for fraud cases)
  
• Interrogatories that follow up on unusual estimates or discrepancies
  

Consulting with a financial expert early in the process can help shape a more targeted and effective discovery strategy.

What Financial Statements Won’t Tell You

Despite their value, financial statements don’t show everything. Key business realities may be hidden or omitted.

What You Won’t Find in the Financials:

• Future business direction or changes in operations
  
• Fraud, unless detected and disclosed
  
• Internal control weaknesses, unless it’s a public company
  
• Intangible asset market value (e.g., brand equity, trade secrets)
  
• Nonrecurring gains/losses that may distort trends

Knowing these limitations helps lawyers avoid overreliance on what’s in black and white.

Key Takeaways

• Financial literacy is essential for lawyers handling business, divorce, insurance, or fraud-related matters.
  
• Core financial documents include the balance sheet, income statement, cash flow statement, and shareholders’ equity.
  
• Understanding accrual vs. cash basis accounting is vital when analyzing discrepancies.
  
• Pay close attention to footnotes—they reveal crucial details hidden in the numbers.
  
• Use accounting experts strategically for valuation, investigation, and expert testimony.
  
• Tailor discovery to obtain financial data that supports your legal arguments.
  
• Remember that financial statements have limitations—complement them with context and expert insight.

For a deeper dive on this topic, watch the full Lawline course “Financial Literacy 101: What Lawyers Need to Know,” presented by Alex Henlin of MGC Law
 and Brian McDonough of PKF O’Connor Davies.

The content of this article is provided for informational purposes only and does not constitute legal advice.

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