Law firm accounting can be difficult. Not only are there the usual aspects of corporate accounting, such as payroll, office purchases, profit and loss statements, and balance sheets, but there are also issue costs and income allocation to consider. Lawyers must additionally consider retainers, fee advances, and trusts on top of everything else.
It takes a great deal of effort to run a law company. Lawyers must maintain vigilance to ensure that their accounting is handled correctly, both for compliance and revenue growth. And for that, it is important to understand the challenges and confront them head-on.
What Are the Challenges in Accounting for Law Firms?
Whether it is accounting for a small law firm or a big corporation, it’s helpful to know where accounting processes can fall short the most. Here are 9 top issues for accounting:
- Capturing Billable Time
This is a common legal accounting mistake that can lead to the ineffective management of work records. Accurate capturing of billable time is the first step towards staying in business. Fortunately, innovations in accounting software allow for easier tracking of time and expenses, from electronic timesheets to time-slip views. Nowadays, many vendors provide invoices in electronic formats that can simply be imported into your billing system.
- Client Trust Fund Accounting
Legal firms, like many other businesses, frequently need deposits before doing any work. These are known as retainers in legal firms. These funds must be kept in a separate account called a Trust Account.
The necessity to handle client ledgers separately while having all trust monies pooled in one bank trust account creates complications for law firms. Law companies must ensure that one client’s funds are not mixed with another’s and that these funds are not used to cover the firm’s expenditures. Utilizing trust accounting software for lawyers is one approach for firms to avoid complications with client trust fund accounting.
- Decision-Making Based on Data
Law companies are still businesses, which means that making educated decisions is essential. Accurate data is required to achieve the greatest results. Accounting is about more than simply compliance. Law firms should compare cash flow to aid in strategic decisions that will improve the firm’s profitability. It will be critical to improve the efficiency of accounts receivable and accounts payable to maintain a consistent cash flow.
Expenses, past-due invoices, and operating cash flow are all variables to keep an eye on. Daily cash reports can help you plan for the future because you’ll be able to identify changes or fluctuations that you can utilize to make informed decisions.
- Differentiating Income and Revenue
When a payment has been made, a percentage of the funds must be used to cover incurred expenses. This component must be tracked independently and is not included in the income calculation. Firms that struggle to distinguish revenue that covers incurred costs from actual income will have inaccurate accounts, compliance concerns, and difficulty identifying which cases have become more valuable to the firm.
- Integrating Legal Billing and Accounting Systems
It is critical for a legal firm’s billing and accounting systems to use the same data sets. The difficulty is, more often than not, rooted in legal firms employing two different systems for their accounting and billing. This means that all financial information must be entered twice, but it must be accurate in both systems. Failure to accurately sync these two systems will result in bookkeeping difficulties, which could lead to billing issues or ethical infractions.
With an integrated billing and accounting system that shows client-related checks and trust account disbursements in one system, you can reduce the time between charging and receiving pay. This eliminates concerns about accounting or billing reconciliation, decreases data entering redundancy, and reduces human errors.
- Posting Revenue
Most businesses accept invoice payments as a single deposit and leave it at that — the money is simply placed into the account, then linked to a chart of accounts and used to calculate tax liabilities. However, many other items must be paid for first to ensure that all costs and liabilities are met.
If you’re accepting a payment, make sure it’s applied in this order:
- Sales tax payable
- Advanced client costs
- Recoverable client costs — hard costs
- Recoverable client costs — soft costs
- Finance charges and late fees
- Fee income
- Proper Accounting of Case Costs
Costs are incurred from the beginning of every case when practicing law. All of these expenses are eventually billed to the client, so all expenses must be fully accounted for. This appears straightforward until you realize that not all charges may be treated equally.
This is where law firms can get themselves into a lot of difficulties. Some accountants may advise you to treat case costs as “Advanced Client Costs” or “Reimbursable Client Costs,” depending on the type of case. Advanced client costs must be recorded as an asset on the firm’s balance sheet, whereas reimbursable client costs must be recorded on the profit-and-loss statement.
If you don’t do it correctly and consistently every time you register an expense, you risk getting in trouble with the Canada Revenue Agency.
Additionally, legal firms must ensure that every expenditure incurred—whether by cash, cheque, or credit card—is immediately allocated to the right subject, or it will not be billed, resulting in a net loss to the company.
- Reporting Compensation
Most systems can generate a standard set of reports, but compensation provides a unique set of issues. Partners and associates are frequently compensated based on a combination of billable hours, receipts, client origination, case or matter management. Look for software that lets you assign a lead attorney and set a fee allocation percentage for each client or subject. Overhead reports will be used by the correct tool to identify specific expenses that can then be divided by chargeable employees.
- Tracking Income
Being a lawyer has its sets of challenges, but it becomes even more challenging when a lawyer decides to run a company. There’s a lot more to consider than a caseload. Simply counting revenue without knowing which practice areas it originated from is a huge disservice to the company. It’s critical to understand how to track and separate transactions.
Making judgments regarding your company’s business without reliable data can lead to costly mistakes and revenue losses. When companies can measure their revenue by case type, they can open up new business prospects by gaining useful business knowledge about different case kinds, allowing them to better allocate their marketing money and resources.
Avoid These Common Legal Accounting Issues
While managing a firm’s accounting might be one of the largest tasks a firm encounters, with the appropriate solutions in place, it can easily shift from a challenge to an opportunity. Consider getting the legal accounting services you need.
Accounting For Law provides accurate and reliable law firm accounting in Toronto. Call (905) 492-5522 to get in touch with us!