[The previous essays in this series are here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, and here.]
It’s not just “business lawyers”—or business-oriented law students—who should be familiar with the construction and interpretation of a company’s basic financial documents: balance sheets, income statements, cash-flow statements, and (for publicly-traded companies) its annual (Form 10-K) and quarterly (Form 10-Q) reports.
For instance, family lawyers might well have clients who are starting, selling, investing in, or sharing ownership of an enterprise.
Health care attorneys could need to assess the financial stability and prospects of a health care provider, or of a manufacturer or distributor of pharmaceuticals.
Any counselor active in ESG (Environmental, Social, and Governance) issues, whether on behalf of management, of shareholders, or of non-shareholder “stakeholders” (such as employees, customers, and residents of areas near a company’s facilities), should be able to evaluate, and possibly challenge, a company’s portrait of its financial status.
These skills would also help lawyers and law students to position themselves to join the boards of for-profit and/or non-profit organizations (although caselaw, regulations, and corporate policies remain surprisingly murky on the “financial literacy” expected of corporate directors).
The first of the ABA’s Model Rules of Professional Conduct, MRPC 1.1, requires lawyers to provide their clients with “competent representation,” which demands “the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representation.”
One might argue that, in this formulation, “legal” modifies not just “knowledge” but also “skill, thoroughness and preparation,” and thus does not include a lawyer’s ability to evaluate financial documents.
In fact, Comment 4 to MRPC 2.1, which concerns the lawyer’s role as “advisor,” clarifies that “Matters that go beyond strictly legal questions may. . . be in the domain of another profession. . . . [B]usiness matters can involve problems within the competence of the accounting profession or of financial specalists.”
Yet the explicit acknowledgment of those situations, and the use of the word, “may,” suggest that less specialized skills, such as the ability to analyze a generic company’s financial statements, can be critical components of a counselor’s competence.
Comment 5 to Rule 1.1 supports this interpretation by adding that, “Competent handling of a particular matter includes inquiry into and analysis of the factual and legal elements of the problem, and use of [appropriate] methods and procedures. . . .” (emphasis added).
To prepare for, accompany, review, or possibly substitute for, a formal course in Accounting and the Law, interested law students and lawyers might find one or more of the following books particularly rewarding:
The Gentlest Introduction
● Karen Berman and Joe Knight’s Financial Intelligence: A Manager’s Guide to Knowing What the Numbers Really Mean (revised edition 2013; 260 pages, plus appendix) is written “not for would-be accountants but for people in organizations—leaders, managers, employees—who need to understand what is happening in their company from a financial perspective and who can use that information to work and manage more effectively. . . . The numbers will no longer scare you. It won’t take long, it’s relatively painless, and it will mean a lot to your career.”
The Most Comprehensive
● Stacey L. Bowers’s Accounting and Corporate Finance for Lawyers (2018; 318 pages, plus appendices) aims to make law students “conversant and able to hold a well-informed conversation with their clients, other lawyers, or accountants regarding the concepts covered.”
Those concepts include: financial statements; the auditing process; issues in accounting; financial terms and covenants in contracts; business valuation; and methods of corporate finance.
The Best Balance of Detail and Accessibility
● Lita Epstein’s Reading Financial Reports for Dummies (4th ed. 2022; 332 pages) addresses the same topics, in a somewhat less formal manner, that Bowers does, and particularly from the perspective of potential investors. Epstein includes helpful chapters on “Recognizing Business Types and Their Tax Rules,” “Scouring the Notes to the Financial Statements,” “Keeping Score When Companies Play Games with Numbers,” and “Ten Signs That a Company’s in Trouble.”
(For a much more extensive discussion, aimed at business-owners, of accounting issues, see Michael Taillard’s 706-page Accounting All-in-One for Dummies (3rd ed. 2022).)
(A valuable guide to identifying and evaluating red flags in 10-K and 10-Q reports is Michelle Leder’s Financial Fine Print: Uncovering a Company’s True Value (2003; 164 pages, plus appendices, one of which provides the summary, “A Cheat Sheet for Reading Key SEC Filings”).)
The Shortest
● John A. Tracy & Tage C. Tracy’s How to Read a Financial Report (9th ed. 2020; 178 pages) emphasizes “the connectivity of the different pieces of information reported in financial statements.”
● W.R. Purcell. Jr.’s Understanding a Company’s Finances: A Graphic Approach (1981; 143 pages, plus appendices [now out of print, but used copies are still available]) illustrates (literally) the author’s opening promise that “All the parts of a company’s financial reports fit together like the parts of a map. Once you see how they fit together, you can turn the reports into a map of the company’s finances.” The book covers balance sheets, income statements, and financial ratios (such as “return on equity”).
The Most Colorful
● More advanced and finance-focused than the previously-mentioned works, Mihir A. Desai’s How Finance Works (2019; 258 pages) provides a wide variety of graphics, and of examples from major domestic and foreign companies, to enhance its discussions of financial statements and ratios.
Chapter 2 (of six) concludes: “All value comes from future cash flows, and making positive net present value decisions is the hallmark of a good steward of capital and manager. Everything else in the remainder of this book will build on those core ideas.”
