Optimizing Your Bookkeeping for Growth Driven Law Firms

When you are running a law firm focused on growth, effective financial management is crucial for success. Bookkeeping, often seen as a routine task, can be transformed into a tool for decision-making.

In this blog post, we’ll share how Firmly Profits can optimize your bookkeeping, particularly focusing on categorizing expenses and wages in a way that provides valuable financial data for informed decision-making.

What is the Difference Between Legal Accounting and Bookkeeping?

The terms legal accounting and bookkeeping often get interchanged. However, they are two different services. Bookkeeping focuses on recording your law firm’s transactions so that they can be tracked and analyzed later. Bookkeepers perform data entry by recording various transactions, including payments, invoices, and expenses.

When the bookkeeping part of the accounting process is done correctly, the rest of the accounting process tends to go smoother. Legal accounting takes bookkeeping records to the next level by analyzing the transactions and interpreting the data, which helps you make better business decisions now and in the future.

What Are the Basic Accounting Principles for Law Firms?

In order to run your law firm efficiently and manage both your money and your clients’ money accurately, you’ll need to understand a few basic accounting principles. In this section, we’ll cover trust accounting and IOLTAs, accrual versus cash basis accounting, expense tracking, generally accepted accounting principles (GAAP), the ethical and regulatory requirements, chart of accounts, double entry bookkeeping, three-way reconciliation, and the basics of financial statements.

Client Trust Accounting (IOLTAs)

One of the most important accounting functions lawyers must perform is handling their clients’ money appropriately. That includes any retainers that the lawyer receives as well as any settlement money. This is why IOLTA accounts are so important. IOLTAs are trust accounts that earn interest, and you might be interested to know that the first account was created by the Florida Bar Foundation in 1981. These accounts are designed to safely store a client’s money until either it’s earned by the lawyer via billable hours, or until it’s time to pay the settlement to the client.

When it comes to correctly and accurately managing IOLTA accounts, lawyers and bookkeepers should keep in mind four items.

1. The lawyer or bookkeeper should familiarize themselves with the account rules for the particular state where the lawyer works.
2. Detailed, up-to-date records must be kept for all client transactions in the trust account. This is where most law firms fall short. They might keep detailed records on the IOLTA account as a whole, but they fail to maintain separate ledgers for each client who has money in the IOLTA.
3. IOLTA trusts for clients should be kept separate from the law firm’s business accounts. Additionally, borrowing from the IOLTA account is strictly forbidden. In order to withdraw money from the trust fund, the lawyer must have completed work, billed the client for the work, and the client must approve the invoice. Only then can the funds be withdrawn from the trust account and deposited into the lawyer’s bank account or the firm’s business bank account.
4. The lawyer must deposit all client checks into the IOLTA trust immediately and record the transaction.

Accrual Vs. Cash Basis Accounting

Law firms have a choice when it comes to the accounting method they use. They can either use accrual accounting or cash basis accounting. Accrual accounting involves recording income and expenses as they occur but prior to when the money is actually received or paid. Cash basis accounting records those transactions on the date the money is received or spent.

For example, in accrual accounting, if a client says they sent a check on the 15th but the law firm doesn’t receive the check until the 18th, the income would be reported on the 15th. If the law firm were using cash basis accounting, the transaction would be recorded on the 18th because that’s the day the cash was received.

Expense Tracking

Bookkeeping involves detailed expense tracking of both hard and soft costs. Hard costs are monies that are paid directly to a vendor on behalf of the client. Some hard costs that your law firm might record include court costs, fees for expert witnesses, lab fees, and deposition fees.

Soft costs are not paid directly to a vendor. Instead, they include things like the rent on your offices, your electric bill, postage, legal research, data storage, and administrative staff costs. All of these expenses must be tracked for tax compliance and billing purposes. You’ll also want to accurately track your expenses to ensure that you’re staying on budget. If you’re not staying on budget, you can use the information to make better business decisions in order to maintain your profitability.

Generally Accepted Accounting Principles (GAAP)

GAAP stands for generally accepted accounting principles, and they were developed and released by the American Institute of Certified Public Accountants (AICPA). Prior to GAAP, businesses set their own accounting and business practices with no standardization. This led to confusion among investors. GAAP was created to help ensure that every business reported their financial statements in the same way so that investors and creditors could easily compare businesses to determine their financial health. The 10 principles of GAAP include consistency, regularity, sincerity, permanence of methods, non-compensation, prudence, continuity, periodicity, materiality, and utmost good faith.

These principles are primarily common sense, and they make good business sense. For example, the principle of regularity insists that accountants adhere to the GAAP principles all the time, not just when it suits them. The principle of consistency states that the accounting practices of the business must be consistent, and if those practices change, those changes must be explained on the income statements, usually in the footnotes. The principles also require honesty and integrity from the business owners, partners, and accountants.

Ethical and Regulatory Requirements

Legal professionals are obligated to follow certain ethical and regulatory requirements. One of those requirements comes from the American Bar Association, and it’s Rule 1.15, which deals with the safekeeping of clients’ property. In fact, that particular rule goes so far as to say that a lawyer should treat other people’s property as if they were a professional fiduciary. Lawyers must also adhere to certain rules of professional conduct, like the attorney/client privilege that protects confidential communications so that clients can be open and honest with their lawyers. It also covers billing transparency. Lawyers are required to clearly disclose in plain language all of the services they provide their clients and the detailed costs associated with those services. If the client is billed by the hour, the attorney must also use accurate timekeeping.

Legal professionals must also take steps to protect their clients’ data and privacy, and if the legal firm is involved in corporate law, real estate deals, or financial transactions, the firm must also be compliant with counter-terrorist financing and anti-money laundering regulations.

Chart of Accounts

Law firms must maintain a chart of accounts. This document is essential for providing investors, shareholders, and financial institutions with a snapshot of the organization’s financial health. It also provides the firm’s owner and partners with an overview of the firm’s expenses and revenue. Your legal firm’s chart of accounts should list every account in your firm’s general ledger by its category.

Double-Entry Bookkeeping

Double-entry bookkeeping is a common method of tracking debits and credits. With this method, each transaction is recorded in a minimum of two accounts. For example, if your business purchases $1,000 of office equipment, your fractional CFO would enter a $1,000 cash or asset account and $1,000 in your accounts payable or liability account. In this scenario, the cash account is a credit, and the accounts payable account is a debit. In double-entry bookkeeping, the debit column must equal the credit column at all times. This method of bookkeeping helps improve cash flow management, reduces errors, and can help spot emerging trends quickly.

Three-Way Reconciliation

Three-way reconciliation is essential for law firms. This accounting practice checks the firm’s internal financial records against their client records and bank statements to make sure everything matches. This method of reconciliation helps ensure that the ABA’s ethical obligations regarding the rules of professional conduct are being adhered to so that the law firm doesn’t incur any disciplinary actions. It helps ensure that all of the client funds are being handled appropriately, and it helps ensure that the law firm is in compliance with IOLTA.

Financial Statements

A law firm’s financial statements include its balance sheets, income, cash flow statements, and shareholder equity statements. These statements are required by GAAP, and they provide the law firm and its shareholders and financial institutions a snapshot of the firm’s financial health. They’re also used to predict future performance and make short and long-term business decisions.

Why Bookkeeping Matters for Law Firms?

Proper bookkeeping helps ensure compliance with the ABA and GAAP. It helps mitigate risk. It streamlines the accounting processes, helps ensure accurate record-keeping, and makes it easier for the managing partners to make informed decisions. It also helps ensure that accurate records are kept and that the documents are ready for any internal and external audits.

What Are the Best Practices in Law Firm Accounting?

When managing your law firm and setting it up for financial, ethical, and compliance success, you’ll want to implement some law firm accounting best practices. This includes implementing robust accounting software, maintaining separate trust accounts for your business and clients, performing regular three-way reconciliations, adopting accrual-based accounting practices, implementing ethical billing practices, and developing a clear bookkeeping system.

Implement Robust Accounting Software

If you want to implement some law firm accounting best practices, start by implementing robust accounting software that allows you to automate some of your accounting tasks. Your legal firm’s accounting system should have specialized features that allow you to manage trust accounts, accurately track time in real-time, and create detailed financial reports that allow you to accurately forecast income and expenses so that you can grow your law firm. The software should also contain ample security features that protect your data and your clients’ data.

Maintain Separate Trust Accounts

Law firms have a fiduciary duty to safeguard their clients’ funds. This means that they must know where those funds are at all times and how those funds are being used. In order to ensure that all the ethical and legal requirements are being followed, law firms must maintain separate client trust funds and business operating accounts. This helps ensure that there is no commingling of funds.

Perform Regular Three-Way Reconciliations

Proper law firm bookkeeping means performing three-way reconciliations regularly, which involves comparing the law firm’s in-house records with the client ledgers and the firm’s bank statements. In most states, the frequency is set by the state bar association. It’s important for lawyers and law firm owners to stay abreast of any changes to the required frequency. Most states require law firms to perform monthly reconciliations.

Establish Case-Specific Reserve Accounts

In order to maintain your financial viability, it’s important to establish case-specific reserve accounts. These financial accounts are designed to manage ongoing costs associated with litigation. This can help prevent a shortfall in funds when handling pro-bono cases and cases that are accepted on contingency.

Conduct Regular Financial Reporting and Analysis

In order to ensure your firm’s ongoing financial health and to find discrepancies quickly, you’ll need to create regular financial reports and analyze those reports. Conducting regular analysis of your financial reports can help you catch high overhead costs before they become a financial burden. They can help you identify your most and least profitable cases, and they can assist you in making strategic business decisions so that your firm can grow and expand.

Implement Ethical Billing Practices

Professionals in the legal industry must implement ethical billing practices and adhere to the ABA guidelines regarding legal fees. The billing must be honest and not misrepresent the time spent working on a case. The lawyer should not double-bill for their time. The lawyer’s services should be accurately explained on the client’s invoice, along with the amount of time spent on each task. Legal professionals should also charge a fair rate, and they should communicate their fees upfront to their clients.

Develop a Clear Bookkeeping System

In order to maintain regulatory and ethics compliance, and stay on top of your firm’s finances, you’ll need to create an organized and consistent approach to bookkeeping. Creating a bookkeeping system that includes a schedule of tasks ensures consistent and accurate financial reporting. It helps keep your records up to date. It helps with tax compliance and audit preparedness, and it helps build client and investor trust.

Set and Monitor Budgets

Being financially responsible and transparent in your legal operations means setting and monitoring your budgets. Set budgets for your various expenses and set revenue targets. Once you have set budgets, you can monitor your expenses and income to see if you’re hitting your benchmarks. If you’re not, you can implement cost control measures and performance tracking to bring your firm back in line with its financial goals.

Stay Compliant with Ethics Regulations

The American Bar Association sets the Rules of Professional Conduct, and those rules include the billing and accounting practices of the law firm. If the firm fails to properly and ethically handle clients’ funds and property, they could be subjected to disciplinary actions from their state bar association, financial penalties, and loss of client trust and the firm’s reputation.

When Should Law Firms Work With Financial Professionals?

Working with financial professionals can help law firms stay in regulatory, ethical, and tax compliance by ensuring accurate bookkeeping and accounting. Law firms should consider working with financial professionals when they need specialized financial advice. This includes when they need to prepare and file tax documents and discuss and implement new tax strategies.

Why Work with Firmly Profits?

Are you ready to take the payroll and bookkeeping services to the next level? At Firmly Profits, we’re dedicated to accurately classifying your wages by breaking them down into specific categories, including attorneys, partners, associates, paralegals, and support staff. Then, we take the categorization a step further by segmenting wages according to the practice area. This approach enables law firms to identify which practice areas are generating the most revenue and which ones may be costing more in wages so that they are better able to strategically plan for the future.

In fact, planning for the future also means knowing where you’re spending your money and where you need to spend your money. For example, do you know how much you’re spending on your day-to-day business expenses and marketing to attract new clients? At Firmly Profits, we can help you track your expenses and income, as well as your wages, so that you can make informed growth decisions.

Testimonials

“Working with Leah Miller, MBA, as our fractional CFO at Proper Paralegal Services has been a game-changer. Leah brings a unique blend of expertise, insight, and enthusiasm that is rare in the financial world. Her strategic approach and financial acumen have been instrumental in steering Propel toward sustained growth and success. Leah’s impact was immediate and profound from the moment we started collaborating> She understands the nuances of financial management and aligns them perfectly with our business goals. Her ability to translate complex financial concepts into actionable strategies is remarkable…” – Heather P.

“We cannot say enough about Leah. Our previous bookkeeper kept the books solely for tax purposes rather than financial projection and insight. Yes, there is a difference, and knowing that NOW has been a game changer. The amount of expertise and knowledge Leah has brought to the table has not only found inefficiencies in our day-to-day operations but has helped us set realistic financial goals. Our investment in LNM Financial has paid for itself tenfold and we recommend Leah to everyone! She has taken the stress out of what we love to do by doing what she loves to do!” – A.P.

“So happy I found Leah! She is my bookkeeper and fractional CFO for my law practice. I no longer worry about having to do it myself on the weekends and can focus on making the money. So grateful for her advice and guidance to reach my big goals. She’s a genuine cheerleader and makes financials easy to digest. Highly recommend her services! She also works seamlessly with my CPA and my books were ready ahead of time!” – Ruma M.

Let’s Discuss Your Bookkeeping Needs—Book Your Free Consultation Today.

If you’re ready to improve your practice management and take control of your law firm’s finances, consider hiring a fractional CFO with more than 10 years of experience in law firm bookkeeping. Call us today at 941-202-4062.