Any business operates under laws that dictate how it manages its finances, but law practices are a special case. Attorneys are subject to more regulations than your average small business, and the penalties for financial mistakes are much more severe. In a recent survey of attorneys, the leading concern was frustration with the practice’s accounting. This article describes the unique needs of legal accounting and solutions to the six biggest challenges related to law practice.
The Basic Tools of Practice Management
Law firm operation can be broken into two areas: practice management and accounting. Practice management encompasses tasks such as matter-based organization, client billing, and task management. Accounting deals with the basics such as profit and loss, but also includes three areas crucial to a legal practice: client funds accounting, matter cost accounting, and back office accounting.
- Client Funds Accounting: Attorneys manage client-owned funds such as retainers, court settlements and real estate escrows. Law practices must manage each client’s funds as a distinct financial entity. The balance sheet must show each client account and the firm’s own assets as separate so there is no misunderstanding about which funds belong to which party. Mistakes with client funds are the leading cause of disbarment actions in the U.S.
- Matter Cost Accounting: Attorneys incur costs that will be billed to the client. This may seem simple on the surface but proper accounting of different costs is complicated. Costs must be categorized correctly: reimbursable client costs show up on the practice’s Profit & Loss Statement, but advanced client costs appear on the firm’s Balance Sheet. Each cost must be tied to the correct matter so they can be billed correctly. Client payments must be entered in such a way as to separate fee payments from cost reimbursement.
- Back Office Accounting: Law firms must not only pay operating expenses ranging from payroll to internet service charges, but must also track how these overhead expenses affect the cost of business operation. More than that, reimbursement for indirect costs (overhead) is accounted for differently than reimbursement for direct costs.
The good news is that a well-designed practice management system that integrates accounting functions makes it easy to handle these tasks, even if you don’t have an accounting background.
Practice Management and Accounting Must Work Together
You need practice management and you need accounting, but don’t make the mistake of trying to manage these two areas separately. The tools you need—and in this day and age, that means the software you need—have to be designed to work together. For example, if you pay an invoice from a client retainer, you mark the matter’s invoice paid in your practice management system, and you adjust balances in both your operating and trust accounts in your accounting system. Let’s look at six areas of law office operation and how an integrated and legal-specific software solution helps overcome these challenges.
- Implementation: Software from different vendors are not designed to work together. Any time you have a problem with one, each developer will blame the other. In an integrated solution, all functions work in harmony, each building on the capabilities of the other.
- Synchronization: Two tools means double entry or clumsy import/export/sync of data. If you ever forget to record the same transaction in both places, you then have to waste time tracking down the discrepancy. In an integrated system, both accounting and practice management systems are always synchronized.
- Matter-Centric Billing: A client payment is a deposit to your accounting system, but your practice management has to apply it to the correct matter so you know invoices associate with a case have been paid for. An integrated solution simplifies billing and collection documentation by eliminating double entry.
- Revenue Tracking: Practice management needs to separate fee payments from expense reimbursement so you don’t accidentally inflate your revenue. If you consider all payments as fees, then the revenue on your Profit and Loss Statement will be incorrect, which means your tax statement will be wrong.
- Practice Area Analysis: It’s not enough to look at the profitability of your law office. You need to examine each practice area to see how your costs measure up to your revenue so you can make strategic decisions about which areas are the most profitable. To do this you need information from both your accounting and practice management systems.
- Practice Overview: A myopic view of your law office can lead to bad decisions. With separated systems, you get focused on small pieces and lose sight of the big picture. An integrated system gives you unified reporting and a high level view of your firm.
Moving from outdated manual systems to using accounting and practice management software will give a big boost to your practice’s efficiency and profitability. Using an integrated system turns the boost into a supercharged solution. Put your integrated system into the cloud, adding mobility and freedom from IT headaches, and you can achieve a level of financial success you never thought possible.
About the Author
CosmoLex (www.cosmolex.com) is a cloud-based law practice management system specifically designed for solo and small law firms. CosmoLex’s CEO, Dr. Rick Kabra (rkabra@cosmolex.com), has years of experience in the legal software industry, catering to the specialized technology needs of small to mid-sized law firms.
(Image Credit: ShutterStock)