When it comes to running a law firm there is one area of the business that may not get the attention it deserves: television has depicted a wide range of attorneys in drama and sitcoms. They range from the flashy Denny Crane in Boston Legal to the every man, bowling alley lawyer Ed Stevens in Ed. Besides both shows being cancelled, what is something they have in common? There is no mention or attention paid to the importance and difficulties associated with legal accounting.
It doesn’t matter if it is a large or small firm, the ability to stay compliant is essential to both success and survival as a law firm. Unfortunately lawyers are extremely susceptible to compliance issues having to deal with their accounting.
Reason number one: they are lawyers, not accountants.
Reason number two: accountants aren’t lawyers and they don’t understand all of the unique elements associated with legal accounting that aren’t associated with generic business accounting.
After all, legal accounting is much more involved than just understanding money in and money out. Successful, compliant law practices must understand the intricacies of client trust fund accounting, direct and indirect matter costs, escrow accounting, and compliant three way reconciliation.
With all of this in mind here are six tips all practices should be mindful of whether they are large or small. Failing to be mindful of these six tips could seal a firm’s fate like Denny Crane and Ed Stevens. But instead of cancellation, the real world penalty is often disbarment.
- Legal practices should employ the use of legal accounting software opposed to general purpose accounting software. Firms that utilize general purpose accounting software will not be able to easily remain compliant while using an out of the box software solution made for general accounting. If a firm were to be successful in doing this, it would require multiple rounds of customization. The process of customizing business accounting software would cost both time and money. The finished product would be far from simple to operate too and would make it more complicated to use and require a higher level of expertise by the bookkeeper or whomever is entering the data. Everyday diligence becomes necessary to ensure transactions are posted correctly. The software must also have customized reports that meet both management needs and are compliant in terms of IOLTA. In the end, what may have started as a shortcut or cost saving measure has turned into a money pit and time suck for any firm who has tried to go without a true legal accounting software solution.
- Reduce data entry errors by avoiding double data entry. At most firms law practice management and business accounting are in two separate systems. The problem is that in many cases the same data needs to be entered into both systems. This means every time a transaction is entered or edited it must be done in both systems. And the problem compounds if firm accepts credit card payments as money trail is lost. If law practices can keep business accounting and practice management in one system- data will only need to be entered once, reducing costly errors and the time spent on data entry inside the practice.
- Maintain “audit ready” trust accounts. Law firms use retainers to secure cash flow from clients. Even though funds may be in the firm’s possession, they do not belong to the firm until they have been earned. Firms also handle personal injury settlements that belong to the client. At any given time a firm will have multiple clients with multiple trust ledgers, it is extremely important that these trust funds are not commingled with one another and are not used to pay the law firm’s expenses. It is mandatory that all trust accounts are reconciled on a monthly basis, and in the event of an audit this is the first thing the auditor will look for. For this reason all law firms need to maintain “audit ready” trust accounts.
- Allocate revenue receipts in the appropriate order. When invoices aren’t paid in full it is important that a firm allocates revenue receipts the correct way. Before a firm applies any of these funds to income, they must pay liabilities and costs first. This process can be made easy with legal accounting software, but in instances where general business accounting software is used a firm is required to split invoice payments manually to different general ledger accounts.
- Keep the firm’s expenses in mind. With all that goes into client billing, it’s easy for a law firm to forget about it’s own expenses. Law firms incur costs associated with the office lease, payroll, electricity, phone, internet, and much more. By having a good understanding of the overhead costs associated with running a firm, better insight can be gained into how much clients should be billed. It is also extremely important to differentiate between direct and indirect matter costs. This is because reimbursement for indirect matter costs requires a different accounting treatment than reimbursement for direct matter costs.
- Income must be tracked by practice area. Firms may specialize in one area, but chances are that there are multiple areas of practice. Furthermore the way a firm bills clients may differentiate across different case types. Once income is tracked by practice area or case type, it becomes easy to understand which practice area generates the most income. This can help maximize financial success for a firm through the ability to make data driven decisions for the business.
About the Author
Dr. Rick Kabra is the CEO of Cosmolex, a leading provider of web-based legal practice management software. Clients rely on CosmoLex as their fully functioning, virtual law office—that lives in the Cloud. CosmoLex’s comprehensive menu of capabilities has replaced the hodgepodge of separate programs and manual clerical work that used to be the norm at law firms. Rick’s vision of offering a “Total Law Practice Solution” in a single login—a platform upon which lawyers can manage & run an entire practice is becoming a reality with each passing day.