Every lawyer knows that money matters, and if you work with an accountant, they will tell you how important it is to be accurate with every detail of your books. Whether you want to shorten the time your legal accounting takes or help out your long-suffering accountant, it pays to take account of your accounting systems.
Here, we review five easy steps that lawyers can use to get solid legal accounting procedures in place, and make life a bit easier for your accountant:
- Create a chart of accounts
- Pick an accounting tool
- Determine the profitability of your firm
- Implement best practices for trust accounting
- Schedule reviews of time entry, billing, and accounting
Step 1: Create a chart of accounts
A chart of accounts is a listing of the accounts available in the accounting system in which you record entries. The chart of accounts consists of both balance sheet accounts (assets, liabilities, stockholders’ equity) and income statement accounts (revenues, expenses, gains, losses).
Many law firms don’t realize just how many accounts need to be tracked to accurately reflect their firm’s value. But gathering all of your various accounts is necessary to begin getting the full value from your legal accounting. Here are some sample charts of accounts that can serve as guides for building your own chart of accounts.
- State Bar of Georgia’s Standard Chart of Accounts for Smaller Law Offices (PDF)
- Law Society of British Columbia’s Online Learning Centre Chart of Accounts (PDF)
You can’t add too many valid accounts to your chart of accounts. Make sure you take an expansive view when building this chart to get everything needed to track your firm’s finances.
Step 2: Pick a legal accounting tool
Now that you have a chart of accounts, pick a tool to track your firm’s finances. Ease of use, integration with your practice management system, and ease of information sharing with your accountant should all be weighed as factors in your decision.
You should also review whether the legal accounting tool can handle cash basis accounting or accrual basis accounting. The main difference between the two systems is when to recognize revenue. While many small firms can get by on cash basis accounting, which recognizes revenue only when it is received, larger firms should use accrual basis accounting.
Accrual basis accounting recognizes revenue when it is earned and is a standard principle of accounting. If you want to work with an accountant, you will need to use accrual basis accounting. Also, many law firms may need to shift to accrual basis accounting if pending legislation is approved. Once you pick a legal accounting tool, enter your chart of accounts, and you’ll be on your way to a better understanding of your firm’s financial position.
Step 3: Determine profitability of firm
The information from your chart of accounts will help determine many financial facts about your firm going forward. You should easily be able to create income statements and balance sheets for your firm from your legal accounting tool. The income statement is also called the profit/loss report.
It subtracts the expenses and losses from the revenues and gains over a measured period of time. Law firms want their income statement to end with positive numbers, which means that a firm is running profitably. However, a positive outcome on an income statement does not mean that the firm is collecting the revenue. Collections are measured in a statement of cash flows. Firms must monitor both income statements and cash flows to remain viable.
Step 4: Implement best practices for trust accounting
Client funds should be stored in a trust account until they are earned or distributed. Law firms should review their jurisdiction’s trust accounting rules to make sure they set up their accounting procedures correctly. Exact trust accounting requirements vary with the jurisdiction, but a good accounting tool should help with assigning and tracking client funds by associating them with both a matter and a client.
This should make it easier to maintain a ledger for clients and matters that tracks transfers, receipts, balances, and more. Legal accounting software also helps with monthly reconciliations and file storage. One tip many law firms can benefit from is to scan and store bank statements, cancelled checks, and monthly reports as PDFs in their accounting system. For example, both Clio and Xero can store files online, associating them with clients and matters. This makes them easily producible in the event of an audit or dispute.
Step 5: Schedule reviews of time entry, billing, and accounting
Law firms should not only set up a legal accounting system, they should also schedule periodic reviews of their accounting information. The frequency of these reviews depends on your firm’s needs. Here are some types of scheduled review that firms may implement:
- Daily – individual lawyers review their daily time entries for completeness and accuracy.
- Weekly – administrators review weekly summaries to make sure that firm billing standards are being met.
- Monthly – administrators and managing lawyers review trust account information and complete reconciliations as part of the billing cycle.
- Quarterly – managing lawyers review their firm’s profitability, running income statements, balance sheets, and statements of cash flow at least this frequently. (These reports will also help solos prepare their quarterly self-employment income tax payments.)
- Annually – managing lawyers review the annual period to determine profitability and to prepare for annual tax filings.
Following these steps will help set up your firm to get an accurate image of your finances. Firms can easily run reports on successes and barriers in their cash flows, without a lot of painful digging for your accountant.
Take the time to set up proper legal accounting procedures and systems—it only takes a few minutes with Clio. Try it for free today.
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Categorized in: Accounting
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