This blog post has been reviewed by Amanda Aguillard, CPA of Aguillard Accounting.
Accounting for law firms is often intimidating—even for seasoned lawyers. While you’ve spent years honing your skills to become a great lawyer, you didn’t learn about accounting or bookkeeping for attorneys at law school.
Here’s the good news: We’ve done much of the leg-work for you.
This guide gives you a practical overview of the fundamentals of bookkeeping for attorneys and accounting for law firms. We’ll introduce the basics of law firm accounting and attorney bookkeeping, including the difference between bookkeeping and accounting, 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.
Do lawyers need accounting?
If you’re the owner of a small law firm, you need to know the essentials of bookkeeping and accounting for law firms. This way, your firm can stay compliant with ethics rules—and you can ensure you aren’t leaving money on the table.
Bookkeeping vs. accounting for law firms
Before we go any further, it’s important to distinguish between two terms that can sometimes be used interchangeably, but shouldn’t be: bookkeeping and accounting.
Legal bookkeepers and legal accountants work with your firm’s financials, with the shared goal of helping your firm financially grow and succeed. But what they do with that data (and when) is different. Each serves a purpose at your firm.
Bookkeepers record the financial transactions and balance the financial accounts for your firm. Legal bookkeeping takes place before any accounting can occur and is an important administrative task for any law firm. Without proper attorney bookkeeping, it’s impossible to track what money is coming (and leaving your firm). This can cause serious issues and stunt your firm’s growth (more on that later). Reliable bookkeeping for attorneys also provides accurate financial data for legal accountants to work with.
Accountants analyze, interpret, and summarize financial data. Legal accountants use financial data that a bookkeeper records as a foundation they can build on to help your firm. They perform tasks for law firms such as preparing financial statements, providing financial forecasting, and capturing expenses.
Why bookkeeping and accounting matter for law firms
“Legal accounting and bookkeeping are 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 accounting for law firms and bookkeeping—a lot.
Effective accounting for law firms is critical to your firm’s success. To ensure your firm’s financial statements are accurate, complete, and up-to-date, you need to use sound bookkeeping for attorneys. 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 some basic commonalities definitely some basics when it comes to accounting for law firms.
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:
- Significant financial penalties.
- Licence suspension.
You need to grow your business
Remember: Your practice is a law firm, but it’s also a business. Accounting for law firms 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. Accounting mistakes make you look unprofessional. And a lack of professionalism can lead to losing your clients, referrals, and growth opportunities.
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 in addition to numerous subcategories. These five core categories are assets, liabilities, owner’s equity, revenue, and expenses.
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.
Learn more about the legal chart of accounts and view examples of formatting.
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). 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). An important rule when it comes to accounting for law firms: 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 is 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. This is common practice in accounting for law firms.
Checking and verifying your financial data periodically is an essential part of accounting for law firms. Three-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 the statement of activity for your trust accounts.
Accounting for law firms: best practices
You’re much more likely to stay organized if you start off organized. By establishing—and following—best practices for accounting for law firms 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 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. Additionally, keep your financial records in check by syncing to a system for accounting for law firms like QuickBooks Online.
Stay on top of trust accounting
Trust and IOLTA accounts are among the most common—and most dangerous—areas of accounting for law firms 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 separate 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 three-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 regularlyon 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 using sound bookkeeping practices to keep accurate records and consistently review the firm’s financial statements on a monthly or weekly basis, you’ll see your firm’s true financial picture. Committing to accounting for law firms will allow you to be better equipped to identify growth opportunities.
Use financial reporting to identify opportunities
Beyond just staying organized and compliant, following best practices for accounting for law firms will help you identify growth opportunities.
A byproduct of good accounting for law firms 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 and bookkeeping mistakes
Lots can go wrong when it comes to accounting for law firms—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 areas where legal accounting mistakes are made. 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 in accounting for law firms. Trust accounting mistakes 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.”
Fortunately, tools like Clio Manage’s trust accounting features can help set up separate ledgers for trust and operating accounts and simplify reconciliation.
2. Incorrectly differentiating income and revenue
Whenever a client pays an invoice, you must allocate the payment to the incurred costs of a matter first. This is a golden rule of accounting for law firms. 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 face 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 in the accounting process. This results in wasted time, mismatched records, billing complications, and even compliance violations.
4. Leaking money
Poor accounting practices, such as struggling to track billable hours or sending out invoices late, can lead to money leakage. Money leakage occurs when funds that should have come in as revenue are lost or not collected. It’s more common than you may think, especially when it comes to accounting for law firms. 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: Clio Payments allows you to bill clients via email, accept online credit card payments, and simplify your billing workflow—making collections more straightforward and secure, so your firm can get paid faster.
5. Avoiding professional help
Just as your clients rely on your expertise with the law, there comes a point when you need to call in accounting professionals. 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. Accounting for law firms becomes so much easier when you work with an accounting professional from the beginning.
How to choose an accountant for your firm
While it’s essential to understand the fundamentals of accounting for law firms, you still aren’t an accountant or bookkeeper. Hiring professionals is common for law firms, and it’s an easy route to peace of mind. This is because a professional legal bookkeeper and accountant can help you manage your firm’s revenue and ensure your firm’s financial transactions are handled ethically and accurately.
Though your firm will benefit from hiring a legal accountant or a legal bookkeeper, enlisting professional help with both tasks can go a long way towards ensuring that your firm’s financials are accurate and handled in your firm’s best interests when it comes to accounting for law firms.
A bookkeeper could be helpful for administrative help with your firm’s finances (like recording transactions, balancing accounts, and creating invoices). But, when it comes to using the data that a bookkeeper records to help your firm (by tasks like preparing financial statements, financial forecasting, and capturing expenses), you need an accountant. An accountant who specializes in accounting for law firms is beneficial. Your best bet is likely to hire both a legal bookkeeper and a legal accountant.
What legal bookkeepers do
Concerning accounting for law firms, bookkeepers deal with the administration of financial recordkeeping at your law firm. Core tasks include:
- Recording financial transactions.
- Balancing financial accounts.
- Bank reconciliations.
- Creating invoices.
- Administering employee payroll.
What to look for in a legal bookkeeper
Much of accounting for law firms comes down to choosing the right legal bookkeeper. They can have a major impact on your firm’s success, so don’t just choose the first person who crosses your path. Here are a few other things to consider:
- Law firm experience: While certain traits make an individual a good bookkeeper in general (the best bookkeepers are incredibly diligent and have close attention to detail), it’s wise to look for a bookkeeper with experience working for law firms.
- Referrals: Don’t be afraid to ask around. Other legal professionals may have had a great experience with a particular bookkeeper, which can guide your search.
- Familiarity with your software: Be sure to check that any potential bookkeeper for your firm understands the accounting software you use.
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. They’re also typically experienced with accounting for law firms. 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 need their services?
- What level of bookkeeping will they need from you?
- Are they experienced with accounting for law firms of your size?
- Can they offer guidance (through reporting or advice) to help your business grow?
Using tech to make legal accounting easier
Why has accounting for law firms traditionally been such a hassle? It involves 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 accounting for law firms, 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 valuable: It eliminated his need for a bookkeeper.
Lastly, did you know you can trial accounting software such as Xero for free? Learn more about free legal accounting software.
QuickBooks Online: For streamlined legal accounting
Working alongside Clio, QuickBooks Online streamlines the process of accounting for law firms by keeping your law firm’s client and financial data perfectly in sync. Allowing you to 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 repetitive 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
InvoiceSherpa supports accounting for law firms by saving you time and energy, increasing your cash flow, and getting invoices paid faster. InvoiceSherpa automates your accounts receivable with reminders and collection software. Because InvoiceSherpa integrates with Clio, you can bring contacts and invoices from Clio directly into InvoiceSherpa.
You can also do this with automated bill reminders in Clio. Automated bill reminders enable you to automatically send outstanding balances to your clients and bill recipients based on a schedule you can customize.
Clio Manage: For legal practice management that supports accounting for law firms
To effectively manage legal accounting for law firms, it’s wise 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 like 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
Legal billing is an integral part of accounting for law firms. And 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. Chris Trebatoski of Treblaw LLC can attest to this: 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.
How to succeed at accounting for law firms and bookkeeping in 2022
Keeping your firm’s accounts in order may not be glamorous. But having up-to-date and accurate bookkeeping records and leveraging professional accountants experienced in accounting for law firms is key to unlocking law firm growth and financial success for your practice. While there are a lot of factors to balance, here are the essentials for law firm accounting and bookkeeping success that you should get a handle on ASAP.
Develop a clear bookkeeping system
If you want your firm to stay compliant, be financially successful, and grow, you need to have an accurate and clear bookkeeping system for your law firm to follow. This could mean taking on bookkeeping tasks in-house or hiring a professional bookkeeper with experience working with law firms.
When it comes to accounting for law firms, whether you handle it yourself or hire someone, your bookkeeping system must maintain a consistent schedule for carrying out bookkeeping tasks. This could be daily, weekly, or even monthly.
Keep strict records
Accounting for law firms requires accurate bookkeeping and accounting records. To make this happen, you must keep and organize documents related to firm financials and attorney bookkeeping, including (but not limited to):
- Receipts and proofs of payments.
- Bills and invoices.
- Credit card and bank statements.
- Any canceled checks.
- Previous tax returns and tax forms.
- Time reports and billing data.
Track your tax deductions
Taxes are a fact of life and accounting for law firms. Interestingly, tax deductions can ease the burden when used correctly—yet not all lawyers are up-to-date on their tax deductions. Why? Many lawyers go to one or the other extreme—they either claim everything (and possibly more than they’re allowed to), or they’re so afraid to overstep they miss out on tax deductions.
When it comes to tax deductions, don’t wait until tax time: Learn about the possible tax deductions that apply to you and your firm, and then track related expenses throughout the year. Doing this can help make doing your taxes easier and potentially maximize your return.
If you’re not sure what tax deductions you should be watching for, our post covering the top tax deductions for lawyers and law firms is a good place to start.
Ensure you have the right bank accounts set up
While this primarily applies to new law firms, ensuring that the basics are determined and set up correctly is critical.
If your law firm doesn’t already have business bank accounts, it’s time to open them. Most firms will need three business bank accounts at a minimum—checking, savings, and a separate IOLTA or trust account. Without the proper business bank accounts, you risk inaccurate bookkeeping, messy records, and potential compliance violations regarding trust funds.
Choose your method for accounting
Similarly, new firms need to choose their preferred accounting method, which must be done before the firm files its first tax return. Consider what’s best for your particular firm (and likely consult with an accounting expert) before making your choice. It can’t be changed in the years to come, and it impacts how you carry out your legal bookkeeping, tax filing, and more.
You can go with an accrual or cash accounting method in the US, and the difference is mostly about timing.
Accrual method accounting. With the accrual method, you record revenue when it’s earned and expenses when they’re incurred—whether they’re paid right away or not. This creates a better matching of costs to the revenues earned in a given month or year. It allows for more meaningful financial management that isn’t influenced by the ups and downs of cash flow.
Cash method accounting. Conversely, cash basis accounting recognizes revenue when you’re paid (i.e. when the cash is received) and expenses when they’re paid. The tax implications of this method also allow your firm to pay tax on income once it’s received and in the bank.
When it comes to accounting for law firms, there’s no one “right” method (though you may be required to take on the accrual method). Some software platforms allow you to use accrual-based books for monthly management of the firm while also creating cash-basis statements for preparing tax returns. Look into the pros and cons of both methods for your firm, then be consistent going forward to ensure your records are accurate and easy to track.
Accounting for law firms may be new or challenging to you, but it doesn’t have to be scary. 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, either as a contractor or as an employee. They can help level up your firm and make the legal accounting process even smoother by adding legal accounting and legal practice management software to your firm’s toolkit. Using legal technology can ease the workload of manual tasks while helping 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.