Successful law firms recognize the strategic value of their law firm accounting.
To effectively run a profitable law firm business, you must understand and manage your law firm accounting so you stay competitive, improve your profit margin and bottom-line and allocate your resources to the right activities.
What are the 6 key components of law firm accounting?
In this article, we will look at six components of successful law firm accounting by looking into trust account management and accounting, managing your law firm’s disbursement and appropriately tracking costs in your accounting records, ensuring you keep accurate records so you can drive strategic business intelligence from your accounting data and more.
This article is divided into the following sections:
- Trust account management and accounting
- Managing law firm case costs, disbursements and expenses
- Distinguish law firm income versus revenue
- Law firm accounting for business intelligence
- Accounting operations for law firms
- Law firm accounting best practices
- Accounting for law firm takeaways
Let’s get started…
1- Trust account management and accounting
Law firms need to manage trust accounts to differentiate money that belongs to the firm and money that still belongs to its client but in the law firm’s possession.
Trust account management and accounting is a crucial law firm accounting operation not only from an ongoing business point of view but also for your law firm’s compliance with local law society rules and regulations related to trust accounts.
Trust account rules can be strict and you must exercise great care in its accounting.
Law firms will use their trust accounts to manage things like taking a retainer fee from a client representing a sum of money to secure the payment of fees for legal services to be rendered.
A law firm may also receive money in trust in order to conclude a business transaction for a client. This money will therefore transit through the law firm’s trust account to facilitate a legal transaction.
Properly managing your law firm’s trust accounting is crucial for the overall success and in making sure you stay on the good side of your law society inspectors and auditors!
Here are a few pointers on the best practices you should implement for your law firm accounting particularly in relation to your trust account management:
- Ensure you track all the funds credited and debited to your trust account
- Ensure that money deposited in your trust account is for a clear purpose such as a retainer, to facilitate a legal transaction or other legitimate purpose
- Ensure that proper validations are in place to deposit or withdraw money from your law firm’s trust account
- Ensure that there is no overdraft to your trust account
- Ensure your law firm does not process business expenses through the trust account
- Make sure that your client’s trust funds are not misallocated to other client accounts
- Ensure you reconcile your trust account with your clients’ accounts and bank accounts, a three-way reconciliation
By implementing the above best practices, your law firm will be smooth-sailing!
Legal accounting software for lawyers can be used to facilitate your trust account management should you want to optimize your law firm accounting processes.
2- Managing law firm case costs, disbursements and expenses
When dealing with a matter, your law firm may be required to pay a process server, court filing fees, costs for an expertise, pay for photocopies, mailing fees and charges and so much more.
You should have a good case cost management system in place to appropriately manage your disbursements.
Some expenses must be charged back to the customer, some expenses should be absorbed by the law firm, some other expenses are paid using money advanced by a client and so on.
To add to this complexity, you will pay some of your case costs through your law firm’s visa, some other times it will be paid by the client, other times you’ll pay through the petty cash, cheque, wire transfer and so on.
This can get quite complicated and tedious with a high volume of financial transactions and activities.
Your law firm’s accounting must meticulously track how your costs are paid, charged to the right party and accurately reflected in your law firm’s books.
At the end of the day, your cost and disbursement management should allow you to quickly pay for the disbursement, quickly get reflected on your client’s invoice if it must be charged back to the client and properly tracked in your accounting records, the bank records and so on.
Some errors here and there can make for a difficult and challenging reconciliation exercise.
Make sure you have the right processes to handle your law firm case expenses so to minimize time loss and accelerate processing.
3- Distinguish law firm income versus revenue
Distinguishing between revenue and income is an important accounting operation that your law firm should not neglect in its accounting operations.
Your total revenue is the total amount of money that you collect from your clients for rendering legal services, getting paid for your disbursements and expenses.
Income is how much your law firm actually has earned excluding the reimbursement for out-of-pocket expenses, disbursements and costs.
To track your law firm’s profitability, you’ll need to properly track your law firm’s income.
In your law firm accounting, you should take your revenue and properly allocate the incoming cash-flow to the right accounts and keep clear accounting records of that.
This exercise is necessary for your own business intelligence, to ensure that you meet your law society compliance and ensure that you are respecting the tax laws by having a correct and accurate income figures.
4- Law firm accounting for business intelligence
Lawyers are lawyers because fundamentally they are not accountants!
However, law firm accounting is a necessary and crucial part of running a law firm business.
Have you thought of your law firm accounting as a gold mine for extracting business intelligence? If not, you should seriously think about it.
If done right, by leveraging your law firm accounting data, you could make strategic business decisions with respect to the type of cases that are the most profitable for your firm, the areas of practice providing the best margins, the possibility for you to penetrate niche markets and possible returns, other profitable regions and so on.
All this information can be found hidden in your law firm accounting data!
The amount of business intelligence your law firm accounting can offer is stunning and quite exciting actually.
For example, you can quickly identify how you can immediately improve your law firm finances in the short-term.
If you have a good and streamlined accounting processes in place allowing you to tap into real-time, accurate and up-to-date data, you can ensure your law firm is progressing in line with your overall objectives and law firm strategies.
5- Accounting operations for law firms
Your law firm accounting operations involve many steps, tasks and processes and it can get quite complicated the more your law firm is active.
Law firm accounting includes the following:
- Legal accounting financial data management
- Legal accounting financial transactions
- Legal accounting recordkeeping
- Legal accounting bookkeeping
- Law firm taxes and filings
- Law firm payroll and internal financial operations
Some law firms will retain the services of external accountants to handle some of these operations, others will hire internal resources while other lawyers handle it themselves.
No matter how you manage your accounting operations, keep in mind that your processes need to allow you to grow your business.
If you are losing time on some accounting tasks, automate them.
If a lawyer is spending a lot of time on accounting related activities, find ways to alleviate that so your lawyers can perform billable work and generate revenues.
If you are paying a lot of money to an external accounting firm or have hired an army of internal clerks and support staff, consider leveraging legal accounting software to reduce your costs.
You can read our article on what to expect from an accounting software for law firms to get more insights on what you will get if you purchase an accounting software.
6- Law firm accounting best practices
Take a moment to step back and look at your law firm accounting processes and see if you are operating based on best accounting practices for law firms.
With this exercise, you should draw a list of accounting practices valuable to your law firm and evaluate how you are handling them.
You will identify areas where you are excelling and other areas where you have significant room to improve.
Take immediate measures to remedy your accounting processes to align them with best practices.
Tackle the low-hanging fruit.
There are a few areas that will require your oversight:
- Your law firm financial reporting
- Your reconciliation activity and record accuracy
- Your accounts payable and expenses
- Your accounts receivable, billing and invoicing
Targeting these four areas will be a great start. Each segment is a vast undertaking, so you better be prepared!
7- Accounting for law firm takeaways
Law firm accounting is complex but a necessity.
You can look at your law firm activity as a tedious and cash consuming activity having little strategic value or you can look at your law firm accounting as a gold mine to tap into business intelligence helping you grow and tap into new opportunities.
In this article, we’ve looked at several components of law firm accounting that is crucial for your overall success such as trust accounts, cash flow management, expense management and so on.
Your law firm’s accounting activity is strategic and you should give it all the importance that it deserves.
Implement law firm accounting processes and operations to maximize the benefit you get from this otherwise necessary evil!
How do you see your law firm accounting? In what ways do you leverage your accounting data to grow your law practice? We would love to hear from you. Drop us a comment!