6 Legal Accounting Tips for Making Data-Driven Business Decisions

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Accounting accuracy can make the difference between a thriving law practice and losing your ability to practice law altogether.

Legal Accounting Tips

Accounting is a serious matter for any law firm. Here are six ways to help your firm make data-driven business decisions that will maximize income while helping you remain compliant.

1. Use Legal Accounting Software Instead of General Purpose Accounting Software

When golfing there are a number of clubs you may use. You can hit a golf ball with every single club in the bag. You wouldn’t tee off with your putter though. It’s a golf club, but it isn’t the right club to use when you are teeing off. Accounting software is similar. General purpose accounting software may be accounting software, but you couldn’t meet a law firm’s needs with it.

Using this accounting software requires customization for legal accounting. But when you customize a generic business accounting software, it makes it more complicated to use and requires a higher level of expertise by the bookkeeper or whomever is entering the data.

For example, a legal accounting software system will provide law practice related general ledger accounts out-of-the-box. It will also facilitate proper use as you do your day-to-day transactional activities, a critical step in preventing errors. True legal accounting software will feature the following general ledger accounts:

  •       Client Trust Funds (Liability)
  •       Client General Retainer – Trust (Liability)
  •       Client General Retainer – Operating (Liability)
  •       Advanced Client Costs (Asset)
  •       Reimbursed Client Expenses (Direct) (Income)
  •       Inhouse Reimbursed Expenses (Indirect) (Income)
  •       Fee Income (Income)
  •       Discount (Income)
  •       Reimbursable Client Costs (Expense)
  •       Non-Reimbursable Client Costs (Expense)
  •       Unrecovered Client Expenses (Expense)

Your software must also have customized reports that meet both management needs and are compliant in terms of IOLTA (Interest on Lawyer Trust Accounts). For example, “Three-Way Reconciliation Report” (which basically reconciles book balance with bank balances AND individual ledger card balances) is one of the most important IOLTA reports. This report would be readily available within a legal accounting software but nearly impossible to produce in a general accounting software.

2. Reduce Data Entry Errors By Avoiding Double Data Entry

At most firms law practice management and business accounting are kept in two separate systems. This is primarily because most law practice management systems, web based or desktop based, do not include business accounting functionality built-in. However, some more popular ones do.

This means every time a transaction is entered or edited it must be done in both systems. If your firm can keep your business accounting and practice management in one system- data will only need to be entered once, reducing costly errors.

For example, CosmoLex, MyCase, and Clio are all-inclusive software systems that bring legal accounting, legal billing, and law practice management together. You are no longer required to enter data multiple times or sync multiple systems.

Legal Accounting Tips

3. Maintain “Audit Ready” Trust Accounts

Most law firms use retainers to secure cash flow from clients. Even though funds may be in the firm’s possession, they do not belong to the firm until they have been earned. Firms also handle personal injury settlements that belong to the client.

At any given time a firm will have multiple clients with multiple trust accounts. It is extremely important that these trust accounts are not commingled with one another and are not used to pay the law firm’s expenses. It is mandatory that all trust accounts are reconciled on a monthly basis, and in the event of an audit this is the first thing the auditor will look for.

Legal accounting software is cognizant of these requirements and designed to provide required protection as a fundamental benefit, and not as an afterthought. Examples include:

Prevention of Co-Mingling

As legal accounting software keeps all transactions matter based, you are automatically protected from the very common mistake of mixing client funds. A properly designed legal accounting software will protect from any type of co-mingling, be it: Client-to-client co-mingling, client-to-law-firm-funds co-mingling, or client’s multiple matters co-mingling.

Overdraft Protection

Legal accounting software will stop your firm from overdrafting a client ledger at the transaction level.

Out-of-the-Box Support for 3-Way Trust Reconciliation

It is required that your administrator perform a 3-way reconciliation every 30 to 60 days. Legal accounting software will make this available to you, automatically, as soon as you complete your monthly bank reconciliation.

Correct Posting of Client Funds

Client funds are not the law firm’s funds and must be posted as liability accounts. Posting these funds incorrectly can result in data discrepancies and penalties levied against your firm. In general accounting software, you are free to post to any general ledger accounts. Legal accounting software requires you to use the correct liability account, removing the potential for costly errors.

In the legal world we all understand that compliance is key. A law firm’s finances are far-from-simple, with myriad client funds accounts and regulations. By employing legal accounting software as opposed to general purpose accounting software your firm won’t even have the opportunity to make costly errors.

4. Allocate Revenue Receipts In The Appropriate Order

When invoices are paid (partially or fully) it is important that your firm allocate revenue receipts the correct way. Before your firm applies any of these funds to income, they must pay liabilities and costs first. This process can be made easy with legal accounting software, but if you’re using general purpose business accounting software your firm is required to split a single invoice into several and apply payments accordingly as per the following schedule:

chart copy

Allocating these funds manually will take several minutes for each invoice payment you enter and also open your firm up to potentially costly errors. Legal accounting software simply and accurately applies all of these funds with one click of the mouse.

5. Keep Your Firm’s Own Expenses in Mind

With all that goes into client billing, it’s easy to forget about your own expenses. Your firm incurs costs, including:

  • Office lease
  • Payroll
  • Electricity
  • Phone
  • Internet
  • Much more

By having a good understanding of the overhead costs associated with running your firm, you’ll gain better insight into how much you should be billing your clients. It is also extremely important that you differentiate between direct and indirect matter costs. This is because reimbursement for indirect matter costs require a different accounting treatment than reimbursement for direct matter costs.

And it gets more complicated. For direct matter costs (e.g. hard costs), your accountant can consider those to be treated as either “Advanced Client Costs” (which is an asset account) or “Reimbursable Client Costs” (which is an expense account). Irrespective of what you choose, your accounting must be consistently foolproof, or the consequences are severe.

An example of foolproof matter cost accounting is compliant default options. such as the below from a legal accounting system:

7-7-2015 12-09-10 PM

6. Track Your Firm’s Income by Practice Area

Your firm may specialize in one area, but chances are you’ve tried more than one type of case. Furthermore, the way your firm bills clients may differ across case types. By tracking your firm’s income by practice area or case type, it’s easier to understand which practice area generates the most income. This will help you maximize financial success for your firm by making data-driven decisions for the business.

Conclusion

Legal accounting is complicated, and doing it wrong can be costly in terms of penalties, inefficiency, and lost opportunities. Using dedicated legal accounting software can make a major difference in your firm’s profitability.

We’ve provided six ways to help your firm make data-driven business decisions. How do you use data to drive better business decisions for your firm? Let us know in the comments!

Header by Abby Kahler

Looking for Legal Billing software? Check out Capterra's list of the best Legal Billing software solutions.

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About the Author

Rick Kabra

Dr. Rick Kabra is the CEO of CosmoLex, a leading provider of web-based legal practice management software. Clients rely on CosmoLex as their fully functioning, virtual law office – that lives in the Cloud. CosmoLex’s comprehensive menu of capabilities has replaced the hodgepodge of separate programs and manual clerical work that used to be the norm at law firms. CosmoLex offers a “Total Law Practice Solution” in a single login — a platform upon which lawyers can manage & run an entire practice.

Comments

Very informative and interesting article, thanks for sharing with us.

Great ways to make data driven business decisions to maximize income. Thanks for sharing!

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