Few things strike fear into the hearts and minds of otherwise-intrepid attorneys quite like the words, “law firm accounting”—and for good reason.
While you’ve spent years honing your skills to become a great lawyer, you didn’t learn about accounting at law school—which might make the thought of law firm accounting pretty intimidating for even seasoned attorneys.
Still, if you’re the owner of a small law firm, you need to know the essentials of legal accounting so that your firm stays compliant with ethics rules—and so that you aren’t inadvertently leaving money on the table.
Here’s the good news: We’ve done a lot of the leg-work for you.
Whether you don’t know where to start, or you’re unsure of what you know (and what you don’t), this guide gives you a practical overview of the legal accounting fundamentals for small law firm owners. We’ll introduce the basics of law firm accounting, including legal accounting terms you need to know, mistakes you should avoid, and the best practices to follow. We’ll also show you how legal accounting software can make the whole process easier (and more effective).
Ready to dive in? Let’s start with the basics.
Why accounting matters for law firms
“Legal accounting is important.”
This statement is obvious… and, yet, a bit nebulous. You know you should care about law firm accounting, but is it clear why you should care, and how much?
The answer? As the owner of a law firm, you should care about legal accounting—a lot.
Effective legal accounting is critical to your firm’s success. To get a rich financial picture and meet your obligations to your firm, clients, and the state bar, your firm needs a clear, accurate accounting system. Here’s why:
You need to stay compliant
Every law firm has a responsibility to stay compliant with ethics regulations, and your firm is no exception. Ethics rules vary in each jurisdiction, but there are definitely some accounting basics that lawyers need to follow.
For example, Rule 1.15 of the ABA’s Model Rules of Professional Conduct outlines key responsibilities for lawyers with regards to holding funds in trust, recordkeeping, and notifying clients of the receipt of funds or property.
Whether intentional or through neglect, violations of compliance regulations—like mishandling client funds—can lead to serious repercussions.
Responsibilities can vary depending on where you practice law (be sure to check the requirements in your jurisdiction), but violating legal accounting rules could lead to:
- Harsh penalties,
- Licence suspension, or even
You need to grow your business
Remember: Your practice is a law firm, but it’s also a business. Legal accounting lets you collect and analyze information, and make data-driven decisions based on what money comes in and leaves your firm—so it’s worth it to pay attention.
Knowing exactly what your firm has coming in (through collections) and going out (through expenses) means you’re less likely to miss out on revenue by accident (i.e., due to billable hours not being recorded, or missing out on tax deduction opportunities). You can also use this information to identify what parts of your practice are most and least successful—so you can more thoughtfully allocate resources to stimulate future growth.
You could be harming your reputation
In the law—as in life—reputation is everything. In addition to threatening your firm’s compliance or losing your firm money, accounting mistakes also look unprofessional—and a lack of professionalism can lose you clients, referrals, and opportunities for growth.
Accounting terms you need to know
No one expects you to moonlight as a CPA, but—if you want to know how accounting impacts your law firm—it’s a good idea to familiarize yourself with legal accounting lingo. We’ve collected a few of the essential terms to know:
Chart of Accounts: This is a list of all your firm’s financial accounts, giving you a framework for where to record every transaction. While the chart of accounts is customized to your law firm’s size, jurisdiction, and practice area, it typically includes five core categories—assets, liabilities, owner’s equity, revenue, and expenses—in addition to numerous subcategories.
The chart of accounts for law firms should include the IOLTA or trust account, as well as a trust liability account (to offset and show that the funds in the IOLTA account are not the law firm’s).
Client Trust Ledger: A statement of activity that shows all of the transactions (beginning balance, deposits in, payments out, and ending balance) for each client.
Double-Entry Accounting: 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.
Assets = Liabilities + Equity
So, with double-entry accounting, every financial transaction gets sorted into a specific category (assets, liabilities, or equity), and once those transactions are sorted, the two sides should match. Double entry accounting is a helpful practice for lawyers to know about, as it provides an extra guard against errors.
Interest on Lawyers Trust Accounts (IOLTA): While the specifics vary from state to state (it’s important to check the details for your jurisdiction), an IOLTA account is a type of bank account from which any interest earned on the account is collected and forwarded to the state bar (usually to funds for social justice). Lawyers are not allowed to collect interest on money held in trust for their clients.
IOLTA accounts are designed to keep client funds separate from your typical business or operating account—where you are allowed to accrue interest. Lawyers also can’t deposit their own funds into an IOLTA account, except to pay service charges (though it’s wise to create a separate operating account or designated credit card to cover fees—so that there’s no risk of accidentally touching client money).
Trust Accounting: The practice of keeping client funds given in trust (including unearned fees paid as a retainer, settlement funds, court fees, or advanced costs) in a separate account from law firm operating funds.
3-Way Reconciliation: Checking and verifying your financial data periodically by checking the following three things. 3-way reconciliation checks can be done manually, or with the help of legal trust accounting software:
- Bank account reconciliation: Check the bank’s version of your balance against what you think your balance should be. If there are any differences, document them.
- Trust reconciliation: Check how much money is owed to other people—that is, ensure you know which client every dollar belongs to.
- Client trust ledger: Check statement of activity about your trust accounts.
Law firm accounting best practices
At her 2017 Clio Cloud Conference presentation explaining key accounting concepts, Amanda Aguillard, CPA, kept things simple: “Accounting is really about organization.”
If you start organized, you’re much more likely to stay organized. By establishing—and following—best practices for your law firm accounting like the examples below, you’ll be better able to help your firm stay on track.
Set a budget
You can’t expect your firm to succeed financially if you don’t set a law firm budget to:
- Set revenue benchmarks
- Create expectations for cash flow and expenses
- Make it easier to set aside funds for big-ticket expenses like annual bar dues
While there are many ways to build your budget, the most important thing is to have a strategy. A few general guidelines?
- Consider your firm’s mandatory expenses and resources—make a list and write it down.
- Set goals, including personal (How many vacations do you want to take in a year?) and business (How fast do you want your firm’s revenues to grow?).
- (Honestly) project your revenues.
- Use software such as Clio Manage to help track your billable time, expenses and revenue, and keep your financial records in check by syncing to an accounting system like QuickBooks Online.
Stay on top of trust accounting
Trust and IOLTA accounts are among the most common—and most dangerous—areas of legal accounting to make an error. Without careful adherence to best practices, it’s all too easy for you or your staff to accidentally commingle funds and put your firm at risk. To follow best practices for trust accounting, you should:
- Keep meticulous records. While the exact requirements vary by your jurisdiction, most State Bar association rules require law firms to keep and maintain detailed records for client trust accounts (you can check your state’s requirements through the American Bar Association’s list here).
- Keep separate accounts. Most recordkeeping rules require attorneys to keep at least two bank accounts—an operating bank account and a seperate IOLTA bank account (again, check the specific requirements for your area).
- Use technology to help. Clio Manage’s trust accounting features makes it easier to manage client funds in trust accounts in accordance with legal industry regulations by:
- Setting up separate ledgers for trust and operating accounts.
- Creating invoices that explain what funds were removed from a trust, and what remains in their trust account.
- Generating trust accounting reports.
- Making it easier to conduct 3-way reconciliations of accounts.
“When we’re looking at the importance of solid accounting,” Amanda said, “we are really talking about looking at financial data on a regular basis. And we can’t do that if we’re not gathering and sorting it on a regular basis.”
Think about it: While most law firm owners recognize the importance of year-end law firm accounting and being prepared for tax time, it’s relatively easy to procrastinate on getting financials in order until it’s time to file.
By consistently reviewing the firm’s financial statements on a monthly—or better, weekly basis—you’ll see your firm’s true financial picture, and you’ll be better equipped to identify opportunities for growth.
Use financial reporting to identify opportunities
Beyond just staying organized and compliant, following best practices for accounting helps you identify growth opportunities.
A byproduct of good law firm accounting is valuable data on the state of your firm. Using financial reporting information, you can make data-driven decisions to positively impact your firm, and find:
- Opportunities to reduce overhead
- Opportunities for financial growth
5 Common legal accounting mistakes
Lots can go wrong when it comes to law firm accounting—especially if you’ve put your firm’s accounting on the backburner. Below, we outline five common legal accounting mistakes (so you can avoid them).
1. Mismanaging trust accounts
Trust accounts are one of the most common places where it’s easy to make a legal accounting mistake. Whether you mismanage the accounts, put funds in the wrong account, accidentally use funds, or fail to report correctly, trust accounting errors are a big deal, as they can lead to penalties, suspension, or even losing the right to practice law.
Fortunately, Amanda has a simple rule of thumb to help keep trust account errors at bay:
“The trust account is not your money,” she said. “It is your client’s money. You can’t mix them. No commingling of funds ever. Like never ever, never ever commingle client funds. You can’t do it, not even for a second.”
Moreover, tools like Clio Manage’s trust accounting features can help by setting up separate ledgers for trust and operating accounts and by simplifying reconciliation.
2. Incorrectly differentiating income and revenue
Whenever an invoice is paid, the incurred costs of a matter must be allocated first. This portion is not income, so it should be logged separately. However, if a firm fails to separate revenue that covers incurred costs from actual revenue, their records will be off.
The result? The firm could meet compliance issues, and their books will be inaccurate (skewing the value of any accounting data derived from them).
3. Data entry errors
To err is human, and to manually input data … is to err. Entering numbers manually often leads to mistakes and duplicated data entry. This results in wasted time, mismatched records, billing complications, and even compliance violations.
4. Leaking money
Poor accounting practices—like struggling to track billable hours or sending out invoices late (or forgetting to send them at all)—can lead to money leakage. Money leakage occurs when funds that should have come in as revenue are lost or not collected, and it’s more common than you may think (According to the average collection rate reported in the 2018 Legal Trends Report, lawyers only collect 85% of what they bill). If your firm is not keeping good books or reviewing financials regularly, these leaks could go unnoticed—which means your firm loses out on hard-earned revenue.
One way to help get your payments on track? A tool like Clio Payments, powered by LawPay, allows you to bill clients via email, accept online credit card payments, and simplify your billing workflow—making collections simpler and more secure, so your firm can get paid faster.
5. Avoiding professional help
Just as your clients turn to your expertise when it comes to the law, there comes a point when you need to call in the professionals for legal accounting. Whether it means using legal accounting software to simplify and automate your accounting, hiring a professional legal accountant, or both—don’t be afraid to delegate when you need to.
How to choose an accountant for your firm
While it’s important that you understand legal accounting, you still aren’t an accountant. Hiring a professional accountant is a common practice for law firms, and it’s an easy route to peace of mind—a professional accountant helps you manage your firm’s revenue and ensures that your firm’s financial transactions are handled ethically and accurately.
Bookkeeper vs. accountant
It’s important to distinguish between two terms that can sometimes be used interchangeably—but shouldn’t be—bookkeepers and accountants.
Bookkeeper: Bookkeepers record the financial transactions for your firm.
Accountant: Accountants analyze, interpret, and summarize financial data.
So, if you need administrative help with your firm’s finances (like recording transactions, balancing accounts, and creating invoices), a bookkeeper could be helpful. But, when it comes to using that data that a bookkeeper records to help your firm (by tasks like preparing financial statements, financial forecasting, and capturing expenses), you need an accountant.
What legal accountants do
A professional legal accountant’s role generally focuses on collecting, interpreting, and using financial data to help a firm stay compliant and grow. Core tasks include:
- Financial data management—including preparing financial statements
- Capturing expenses
- Completing tax returns
- Client trust accounting
- Case cost accounting
- Separating revenue from income
What to look for in a legal accountant
While the person (or people) you hire should be tailored to the needs of your unique practice, there are some general questions you can ask:
- Are they familiar with the specific rules and regulations for your jurisdiction?
- What technology do they use as part of their accounting process?
- Does your firm require an employee or a contractor?
- How often will you require their services?
- What level of bookkeeping will they require from you?
- Are they experienced with accounting with firms your size?
- Can they offer guidance (through reporting or advice) to help your business grow?
Tech makes things easier
One of the reasons that accounting has traditionally been such a hassle for law firms? It involved a ton of inefficient, manual work—involving a lot of spreadsheets, paper invoices, inputting data entry, and struggles with collections.
Luckily, as Amanda noted, “Technology can be used to ease these pain points when it comes to legal accounting.” Here are a few examples of options that can do just that:
Xero: For easier online accounting
Designed specifically for small businesses and their advisors, Xero’s online accounting software simplifies financial management for your law firm, letting you:
- Take care of accounting from anywhere, anytime while you’re on the go.
- Get paid faster with customized online invoices.
- Make better business decisions with the help of a real-time view of your firm’s cash flow.
- Reconcile accounts in seconds.
And, with the Clio and Xero integration, your firm can automatically connect client invoices and expenses logged in Clio with Xero—creating a seamless link between the accounting and billing process. For attorney Andrew Legrand of Spera Law Group, this integration is so useful, it’s eliminated his need for a bookkeeper altogether.
QuickBooks Online: For streamlined legal accounting
Working alongside Clio, QuickBooks Online streamlines the process of legal accounting by keeping your law firm’s client and financial data perfectly in sync—letting you quickly and easily sync your firm’s contacts, bills, and transactions from Clio’s practice management software to QuickBooks’ cloud-based accounting platform. With QuickBooks and Clio, you can:
- Sync contacts, invoices, financial information, and transactions to eliminate repeat data entry
- Manage amounts in both Operating and Trust accounts
- Sync payments and credit notes applied to bills in Clio to QuickBooks Online
- Use an automated trust workflow to ensure that amounts in trust are reconciled between Clio, QuickBooks Online, and your associated bank accounts
- Ensure simple and accurate data management and reporting
InvoiceSherpa: For automating payment reminders
Save time and energy, increase your cash flow, and get invoices paid faster by automating your accounts receivable with InvoiceSherpa’s invoice reminder and collection software. Because InvoiceSherpa integrates with Clio, you can bring contacts and invoices from Clio directly into InvoiceSherpa.
Clio Manage: For legal practice management that supports legal accounting
To effectively manage your legal accounting, it’s smart to start with a foundation that works for all aspects of running your firm. Clio Manage’s cloud-based legal practice management software helps you run your firm—allowing lawyers to track their time and expenses, collaborate with clients, accept credit card payments, and conduct core accounting tasks—all from one platform.
Integrations to link general and trust accounting
Both general accounting and trust accounting are necessary for your firm’s success—and integrations seamlessly tie the two areas together.
Integrations connect Clio’s trust accounting management features (like setting up separate trust and operating account ledgers and generating reports for trust accounting compliance) with the general accounting features (like creating financial reports and reconciling accounts) of online accounting software programs QuickBooks Online and Xero. This gives you the best of both worlds, while making your law firm’s comprehensive accounting situation easier to manage.
Better legal billing
When it comes to legal billing, software like Clio Manage can make the process run smoother, too. Clio’s legal billing features let you bill securely, create branded invoices, and automate billing, so you can get paid faster—as Chris Trebatoski of Treblaw LLC can attest to: While Chris used to labor for days over billing at a larger firm, Chris now gets all his bills out each month in a matter of 15 minutes with Clio.
Legal accounting may be new to you, but it doesn’t have to be scary. At the end of the day, what’s most important is that you get the details right so that you can stay compliant with ethics rules and help your firm grow to its full potential.
Once you understand the basics, consider hiring an accountant, as a contractor or as an employee, to your team to help you level your firm up, and make the legal accounting process even smoother by adding legal accounting software and legal practice management software to your firm’s toolkit. By using legal technology, you can ease your workload of manual tasks while helping to your firm meet its goals—avoiding errors, ensuring compliance, and staying organized.
Note: The information in this article applies only to US practices. This post is provided for informational purposes only. It does not constitute legal, business, or accounting advice.
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Categorized in: Accounting