Legal Accounting for Beginners
For legal firms, accounting goes beyond merely reconciling a bank statement or keeping a ledger of invoices. Accounting in professional services, and law firms are no exception, is a fundamental business process that is at the very heart of the sustainability of the entire enterprise. Accounting is the means by which firms track revenue, expenses, and profitability. But legal accounting covers more than the balance sheet and the profit and loss reports. There are unique financial needs and regulatory requirements that make accounting for legal firms much more complicated than , say, the accounting department of a supermarket. Law firms must handle trust accounting; they must generate invoices and track client payments; and they have to manage matters (i.e., cases) so that they track every incremental expense. All these tasks are done with an eye on regulatory compliance. Law firms, like other professional services entities, often operate under fixed fee arrangements or alternative billing structures and therefore must have the tools and know-how to deal with revenue management and compliance.
Creating a Winning Accounting Set-up
An efficient accounting system is a must when clients’ trust funds and cash needs to be aggregated for accounting purposes. But being able to run reports, report transactions by client, and have software with the flexibility to add new features and integrations makes an accounting system even more valuable. If your firm hires a third-party accounting provider, it’s essential that your staff and that person or team work seamlessly. And you need to be able to train new staff quickly on the use of the system so they can ramp up without much interruption. Accounting systems should also allow you to set up different user levels and permissions — enabling administrative access for partners, and limited access for junior accountants, attorneys and others. Having a system in place that tracks all incoming and outgoing payments — including auto-generated reports — is imperative. Particular fields relevant to legal work include: Different accounting software packages exist to accommodate those fields and all of the other requirements above. Some popular packages include Xero, Sage Intacct and Zoho Books, which is popular among small firms. QuickBooks and FreshBooks are especially popular packages for smaller companies. The software you choose should integrate with other business critical systems, including: Legal-specific software, such as Clio Grow, which is used for customer retention, can also help you stay compliant and help steer business. Finally, there are a few things to look for in an accounting software, according to Software Advice, including: Many of these packages are simple — and quick — to set up. The key is to make sure that everything is functioning as it should. At Clark Schaeffer Hackett, we specialize in law firm accounting. Improvements in the industry mean that we work with more systems than ever. Beyond those mentioned, we use Firm Central, Lean Law, Timeslips and Enterpriser.
How to Manage Client Trust Accounts
The purpose of the client trust account is to protect client funds and subject to its use by the legal practitioner according to the instructions of the client, and once the funds have been used for the purpose intended, the client trust account should not be used for any other purpose. The client trust account is considered property belonging to the client.
The Legal Profession Uniform Law (NSW) provides a number of compliance requirements that must be met. Client trust accounts can only be in the form of an interest bearing trust account or a general trust account. Interest bearing trust accounts may be offered by an Authorised Deposit-taking Institution (ADI) and any interest accrued on the account must be paid, as soon as practicable, into a special trust account for the sole benefit of clients who have funds held in the account. This requirement does not apply if the legal firm has entered into an agreement with the ADI that operates to fix the interest on the account at zero.
Legal practitioners and law practices must keep all records relating to their client trust money. The information must be current, up-to-date and accessible. Quality record-keeping is essential to ensure that there is not only compliance with laws and regulations, but also that the ADI maintains the right accounts with the right amounts being reported. Records must be kept for all dealings in trust and general trust accounts for at least 7 years from the date the account is closed.
The compliance and reporting obligations are significant and failure to comply with such obligations can result in significant fines and/or disciplinary action being taken against the legal practitioner or firm. Therefore, it is essential to get this right the first time.
The Art of Effective Legal Billing
To ensure that you understand your time expenditure and how clients are billed, we need to look at billing. Getting paid is clearly important, as is tracking and being able to talk about what you have and haven’t done and how much time you’ve spent; time in which you can directly identify a matter and bring in the relevant fee arrangements and percentages of time expended. This is very important because one of the elements that’s changed over time is that clients are increasingly wanting to use time recording as a management tool. As such, they want to know when certain work was done, how long it took, the cost and, ideally, how much they’re up to or who has worked on their matter. Lawyers need to understand that, in the past, partners were the ones who recorded the time. They’re now relying on administration staff to hold people accountable. Partners and equity partners, and even senior associates, are sometimes the ones who think they are immune from the time recording process because they are time billers or are in control of the file, so they can make their own decisions about the time and how it’s recorded. They do. However, most clients want to know that you’ve actually undertaken the work. Some clients don’t accept non-time recorded work at all, in which case it’s a disciplinary action. On an administration level, there is some responsibility on the invoice, so if you’re not recording the times, then you’re letting someone else be accountable for that. To make things fair, it’s long been recognised that people who are managing at firm level sometimes won’t get directly involved in the time or billings process, so there’s some equity about that; it’s the same with client involvement. It’s perfectly reasonable that your senior partner doesn’t record time, but is it also reasonably equitable that they are not accountable for aspects of their matter that haven’t had time allocated to them and therefore can’t be measured against, as opposed to when it’s a non-partner. So there’s always some environmental, administration equity about those sorts of things. We all know that for all lawyers there needs to be time recorded for all of your work. Let’s think about how we’re doing it, how we can improve it. Look at the processes. So, instead of thinking I haven’t got time to do this, think about the ways in which you can change the way your doing it and be happy with what you are coming up against. I mean, asking yourself, ‘What is our process?’ How can we make this more efficient? The client wants the expense, they want to pay it, but the matter that you are asking questions about is just labelling. So, you’ve got to understand it, don’t let anyone have an arbitrary view of things.
Legal Tax Accounting: What you need to know
Like any other business, an accounting system for a legal firm must be able to abide by the tax controls stipulated by the IRS. One of the most important obligations of any business is to deduct and withhold taxes as legally required. The qualifications for taking certain deductions, such as expenditures for items like the rent for an office, utilities or office supplies, must be determined based on what will actually be considered deductible according to the IRS tax code, and what will not be.
It is just as important for a law firm to maintain accurate financial records throughout each month of the year. Without precise accounting of your firm’s revenue and expenses, this will result in inaccurate financial reporting and tax implications for your business.
Given that a legal firm does not have any inventory, the income and cost of goods sold items will be the same. This basically means that the firm will be reporting gross receipts as the entire amount of its income earned and the expenses being the direct costs , or cost of goods sold.
There are multiple deductions that can be applied to a law firm’s revenues, including costs of business property and expenses for any outside services. Deductions must be listed as ordinary, necessary and reasonable. It’s vital for all accounting and finances for a firm to be reviewed by a qualified tax professional annually.
Being smart about a tax strategy for a legal firm is advised in order for it to get through tax season without incurring expensive mistakes. Businesses that utilize the calendar year in accounting for their taxes are able to file their annual return by April 15, while those who utilize the fiscal year will file by the 15th day of the 4th month after the end of the firm’s fiscal year.
Law firms must ensure they are in compliance with maintaining a proper accounting system, and consult with a qualified tax professional. For a firm to be able to maximize its success, accuracy is paramount in both accounting and a legal firm’s tax strategy.
Reading the Financial Health of Legal Companies
To maintain a thriving business, legal firms need to keep a close check on their finances. The process of assessing a law firm’s financial health involves examining several key components, including cash flow analysis, budgeting, and even profitability in some cases. Cash flow is one of the most important aspects of a law firm’s overall financial well-being. Not only must a law firm effectively manage the cash coming into and out of the business, it needs to have sufficient liquidity to handle its current needs while planning for future growth. Instead of using a "wait and see" approach to financial management, there are strategies firms can use to anticipate and manage their cash flow needs, including:
Budgeting is an equally important tool for assessing a firm’s financial health. It gives firms the ability to compare their overall financial situation against their plans and spot any potential problems before they become significant. However, many legal firms take their budgeting process too lightly, not using it as an integral part of their financial health checks. Profits are the third fundamental component of financial health. While it may not be critical for law firms to earn a profit if they are functioning as expected, the reality is many firms find getting back into the black more difficult than getting into the red. For this reason, profitability must be monitored differently than other financial targets for sound financial management.
Accounting Outsourcing for Law Firms
Outsourcing accounting functions has become a common practice for legal firms, presenting a cost-effective solution to managing financial responsibilities. However, there are pros and cons to consider before deciding to turn-over these crucial tasks to an external provider.
One of the primary advantages of outsourcing is cost-effectiveness. Legal firms can access professional accounting services without the long-term commitment of hiring a full-time employee. This helps small to mid-sized firms who may not require a dedicated accountant year-round but still need assistance during busy seasons or during tax time.
Outsourcing also provides access to specialist’s skills and resources. A dedicated accounting provider can offer a team of professionals with varied expertise, ensuring that your financial records benefit from a diverse skill set. Additionally, such providers have access to the latest financial management technologies and tools which can further streamline your accounting processes.
However, outsourcing comes with its share of disadvantages . One significant downside is the loss of control. When you outsource your accounting tasks, you are placing your financial data in the hands of another firm. If there are issues down the line, addressing them can become complicated, especially if you have signed a long-term contract.
Another downside is the potential lack of personalized service. You want your accounting provider to be familiar with the specifics of your firm, and sometimes those details can get lost in translation.
So, if you’ve decided outsourcing is the right choice for your firm here are some tips on choosing the right provider:
• Ensure the provider specializes in legal accounting to benefit from familiarity with your regulations.
• Look for a provider with a solid reputation and referrals from other legal firm clients.
• Make sure they are knowledgeable about the legal industry and up to date with technology.
Outsourcing accounting functions to a skilled provider can free up your time and resources to focus on your legal work. But you should always weigh the pros and cons before starting an engagement.