Firms in high-growth mode need more cash to get new space or make an acquisition. When you don’t collect funds that you’re owed, you miss out on revenue and are essentially working for free. And when you’re missing out on 12% of your billable hours, that’s 4.8 hours in a standard 40-hour workweek.
Legal bookkeepers and legal accountants work with your firm’s financials, with the shared goal of helping your firm financially grow and succeed. We’ll also show you how law firm accounting legal accounting software can make the whole process easier (and more effective). How your business pays income tax is determined by your business’s legal structure.
However, there are a couple of unique aspects to law firm accounting, and managing them can be challenging. Most notably, lawyers often hold onto funds that don’t belong to them, and specific rules govern how you need to handle that cash. Specialized accounting software is crucial for law firms as it caters to the unique financial and compliance needs of the legal industry.
IOLTA accounts are designed to keep client funds separate from your typical business or operating account—where you are allowed to accrue interest. Without proper attorney bookkeeping, it’s impossible to track what money is coming (and leaving your firm). This can cause serious issues and stunt your firm’s growth (more on that later).
However, this method does not recognize accounts receivable or accounts payable. Most law firms use cash basis accounting because it’s simple to maintain. Without a professional accountant, you risk mixing up revenue and income, two different types of proceeds. Revenue refers to the money, https://business-accounting.net/ payments, and proceeds your firm receives. On the other hand, income refers to what is left over after the firm’s costs and expenses have been deducted from the revenue. Taxes, property expenses, legal dues, and payroll are typical expenses law firms must deduct from revenue to get income.
For a CPA to work effectively, they will need you to provide accurate, up-to-date financial statements. Whether you’re good with numbers and spreadsheets or not, every lawyer needs to understand the basic role that bookkeeping plays in their business. Unless the IRS requires you to use the accrual method—for law firms, this rule only kicks in once you start making $10m a year—which method is best will depend on your accounting needs. Your business’s accounting method will affect cash flow, tax filing, and even how you do your bookkeeping.
Adhering to best practices in trust account management is essential to maintain transparency, compliance, and ethical standards. Creating an accurate, detailed legal chart of accounts is an important tool to give you an accurate picture of where your firm’s financials stand. Once set up, this information can give the visibility you need to ensure your firm stays compliant with accounting and trust accounting rules. Moreover, you can use the information from your law firm’s chart of accounts to help determine key financial details about your firm—which is necessary for making data-driven decisions. When setting up your chart of accounts, be sure to pay special attention to your handling of trust liability accounts to ensure you are keeping accurate records and following the rules.
With the knowledge you’ve gained, you’re well on your way to better financial health. The hope is that, by knowing where your money is coming and going, you can spend more wisely and capitalize on valuable opportunities. Data entry errors lead to wasted time, as you comb through records to figure out what the error is, as well as billing complications and compliance violations in the worst cases.
Finances are one of the most critical areas of your law firm, and you should be involved with them. While your bookkeeper will be handling all the daily tasks of adding, subtracting, and balancing, you need to be aware of where your firm’s finances stand and how those finances got to where they are. A standard report can tell you the first piece of information but not the second one. Accounting for law firms becomes so much easier when you work with an accounting professional from the beginning. Double-entry accounting is a system of bookkeeping where every entry to an account (i.e., every financial transaction) requires a corresponding and opposite entry to a different account. A double entry system, therefore, has two equal and corresponding sides—or debits and credits—and creates a balance sheet consisting of assets, liabilities, and equity.
The last thing a new law firm needs is to get on the wrong side of the IRS. Consider consulting with an accounting firm to clarify your responsibilities and ensure you’re meeting them. Meanwhile, the accrual basis of accounting involves recognizing revenues when you earn them and expenses when you incur them. That requires significantly more expertise and forces you to keep track of accounts receivable and payable.
That’s challenging in any industry, but it can be especially difficult for a small law firm. Not only do you have to keep track of which transactions are personal and which are business, but you also need to know which costs you incur on behalf of your clients. Fortunately, most accounting concepts for law firms are relatively straightforward.
This allows you to determine which cases are the most profitable, which ones drain the most resources, and where money is being spent but not made. Trust accounts are among the most common areas of accounting for law firms to make errors because they have very specific rules about what you can and can’t do with them. The penalties for breaking these rules can be severe, including disbarment. Staying on top of your law firm’s accounting responsibilities while providing legal services to clients can be a significant challenge.
The asset and liability amounts should always match, making no impact on your financial statements. While other CTAs earn interest for clients, IOLTAs send the interest to state-sponsored programs that fund law school scholarships and law services for the poor. Any money that your business holds onto for a client and hasn’t earned goes into a client trust account (CTA).
A law firm chart of accounts serves as a comprehensive list of all of a legal practice’s financial accounts. It also provides a framework for recording every financial transaction at the firm. Making the jump from an attorney to running a law firm can bring a ton of new intimidating challenges. Legal accounting and attorney bookkeeping are surely one of the largest you face. That’s why we recommend you should hire a professional legal account.
All accounts appear either on a Balance Sheet or an Income Statement. Now you cross off law bookkeeping out of your to-do list and feel stress-free about the financial aspect. As a result, you take comfort in allowing yourself to offload financial tasks and turn your attention exclusively to business development and legal cases. Law firms can use double-entry bookkeeping as a way to better monitor the financial health of a company.
