Best Practices

Law Firm Accounting and Bookkeeping 101

Hannah Bruno
Hannah Bruno
November 14, 2022

You're a lawyer, not an accountant. We know you'd like to spend your limited time in other ways. But setting up your finances properly won't just make it easier to file your taxes each year—it'll save you time, money, stress, and potentially legal trouble (yes, really!).

When implementing a legal accounting strategy in your firm, there is plenty to consider. From creating a budget, choosing the right bank, hiring the correct advisors, and deciding on which type of accounting your firm will do—it all can feel overwhelming.

Step back, and take a deep breath; we are here to help. The following guide explains the fundamentals of law firm accounting and bookkeeping. We'll also show you how you can make the whole process easier. Interested in learning more? Let's start with the basics.

Improve-Accounts-Receivable-Collections-600x200-Body-07-DemoCTA

Why is Law Firm Accounting Important?

The short answer? The success of your law firm depends on effective accounting. The firm needs a clear, accurate accounting system to get a complete financial picture and meet its obligations to clients, the state bar, and the firm. Here's why:

  • You need to stay compliant. Compliance regulations can vary depending on where you practice law, but violating legal accounting rules could lead to significant financial penalties, license suspension, or even disbarment.

  • You need to grow your business. With law firm accounting, you can collect, analyze, and make data-driven decisions based on the money coming in and going out of your firm. Using this information, you can also identify which parts of your practice are the most and least successful so that you can allocate resources more thoughtfully in the future.

  • You need to manage your reputation. A lawyer's reputation is crucial. Accounting mistakes make you look unprofessional. And a lack of professionalism can lead to losing your clients, referrals, and growth opportunities.

Legal Accounting Tips

Set a budget for your law firm

The basis of good legal accounting always starts with a well-thought-out budget. A budget helps you set expectations regarding cash flow and expenses for the year, reducing the likelihood of missing a payment or bouncing a check. Your law firm will also be able to set revenue benchmarks, which will help you determine if you are meeting your goals or need to adjust your business plan.

  1. Brainstorm your firm's expenses: The first step is the easiest: Brainstorm mandatory expenses. You'll also want to outline what resources you have on hand (starting capital, existing equipment, etc.) and set aside some money, either as a recurring expense or a percentage of your revenue, for any potential surprises you encounter. For each line item you consider adding to your budget, ask yourself three big questions: Will this save me time to put towards more billable work? Will this help me find more business? Do the benefits outweigh the cost?

  2. Project your revenue: Once you've itemized all the expenses, the next step is to project your expected revenues. This can be considered a mapping exercise, as a budget should be your guiding point to building a successful law firm. Incorporating your personal and business goals into the process is also a good idea. Be sure to set your rates carefully, factoring in the objectives above as well as average rates for your location and practice area.

  3. Document and track your budget: It's a good idea to assess every month after collecting all your bills when you're starting out. This will give you a sense of whether you need to adjust your projections or document any expenses you didn't account for. It's also a good idea to set aside time to formally review your budget each year.

Set up your firm's bank accounts

As every business is different, your choice of the "right bank" depends on the nature of your practice, as well as how you prefer to handle your banking transactions.

  • When comparing options, consider the following questions:
  • Does the bank support your Point of Sale (POS) system?
  • What does the bank offer in terms of security and fraud protection?
  • Does the bank's online banking option let you designate separate users (for business partners, if necessary)?
  • What kind of fees are they going to charge you?

To open any business bank account, your practice needs to be registered with the state in which you are operating, have a registered business name, and have an Employer Identification Number (EIN). Before meeting with a bank representative, call ahead and ask what paperwork you need to bring to your initial appointment.

What types of bank accounts does your firm need?

Once you've chosen a bank to work with, there are three types of accounts you'll want to open:

  1. Business Checking Account: You will manage most of your business expenses and revenue from your checking account.

  2. Business savings account: Set aside money you'll need later (for emergencies, to pay taxes, etc.) in a savings account. Even though interest rates on business accounts are traditionally low, having a cash surplus in a business savings account can improve your likelihood of being approved for a loan. It's also an excellent place to store money aside for taxes and emergencies.

  3. IOLTA Account: In addition to their business checking and savings accounts, most law firms are required to hold client funds in a separate trust account—often called an "IOLTA”. IOLTA accounts are tricky because they have very specific rules around what you can and can't do with them, and the penalties for breaking these rules can be severe, including disbarment. For peace of mind, we recommend seeking a payment and billing provider that adheres to IOLTA account rules. LawPay protects your trust account against third-party debiting and commingling funds—ensuring compliance with ABA and IOLTA account rules.

Every state has an IOLTA program, and it's likely that the bank where you opened your regular business checking account also offers IOLTA accounts. But rules vary by state, so consult your State Bar Association and a professional accountant before finalizing your accounting setup.

Keep comprehensive law firm records

Your bookkeeper, CPA, and the IRS all require you to keep documents proving your income, credits, and deductions.

Therefore, you should hold onto the following:

  • Receipts
  • Bank and credit card statements
  • Bills
  • Canceled checks
  • Invoices
  • Proof of payments
  • Financial statements from Bench or your bookkeeper
  • Previous tax returns
  • W2 and 1099 forms
  • Accounts Receivable journal showing billed receivables
  • Case time records per client
  • Time summary reports, sorted by attorney and by client.These should list the time, dates of work, billings, and/or charges (legal management software, like MyCase, can help you track this)
  • Register of cases in progress, often organized by client's name.
  • Any other documentary evidence that supports an item of income, a deduction, or a credit shown on your tax return.

Each of these records should be kept for a specific time—some for 10 years, some for as few as three. The IRS doesn't require you to keep records of certain expenses under $75, but we still recommend that to be safe, you keep copies of all records.

Choose an accounting method

You'll also want to decide how your firm will track incoming and outgoing funds. Your business's accounting method will affect cash flow, tax filing, and even how you do your bookkeeping. You'll need to choose an accounting method before your firm files its first tax return, and then stick with it on all subsequent returns.

Law firms can elect to use one of two accounting methods: cash accounting or accrual accounting.

Cash accounting

Cash accounting recognizes revenues when cash is received, as well as expenses when paid. However, this method does not recognize accounts receivable or accounts payable. Most law firms use cash basis accounting because it's simple to maintain.

Pros:

  • Cash accounting makes it easy to determine when a transaction has occurred
  • Easy to track how much cash the business actually has at any given time
  • Income isn't taxed until it is in the bank

Cons:

  • Gives your business a limited look at your income and expenses
  • More IRS guidelines and restrictions

Accrual accounting

Accrual accounting records revenues and expenses when earned and incurred, regardless of when the money is received or paid. For example, when you send an invoice to a client, you'll mark it as revenue, even though you might not get paid for 30 days.

Pros:

  • Gives a more realistic idea of income and expenses during a period of time.
  • Better for firms that experience large, rapid changes in their revenues

Cons:

  • Accrual accounting doesn't clearly indicate a business's actual cash flow
  • Must offset risks by carefully monitoring cash flow with accounts receivable and accounts payable

What is the Difference Between Legal Accounting and Bookkeeping?

The terms bookkeeping and accounting can sometimes be used interchangeably. However, they are vastly different. 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) varies. Regardless, each serves a purpose at your firm.

Law firm bookkeeping

Law firm bookkeeping records the financial transactions and balances the financial accounts for your firm. Legal bookkeeping takes place before any accounting can occur and is an essential administrative task for any law firm. Reliable bookkeeping for attorneys also provides accurate financial data for legal accountants to work with.

Legal accounting

Accounting serves to 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.

Should Your Law Firm Hire a Bookkeeper and an Accountant?

Managing your books via accounting software may get you started as a solo attorney. But, if you want to spend your time focused on practicing law rather than deep in the weeds of your firm's finances, you'll likely want to consider hiring help. There are several options available. One (or more) of these professionals can greatly assist with your law firm accounting.

Bookkeeper

A bookkeeper records the daily transactions of your firm. In addition, your bookkeeper may help you process and send invoices, process your accounts payable, manage payroll, and run routine financial reports.

In short: If you'd like to save time and keep your finances a little more organized, a bookkeeper can help keep your records updated and your business expenses categorized.

Controller

While a bookkeeper keeps the day-to-day data accurate and updated, a Controller can help you set up and oversee your financial system and accounting infrastructure. Controllers often oversee the bookkeeper's work, reconcile the accounts, and make more significant ledger adjustments.

In short: If you'd like a deeper understanding of financial trends within your business, a controller can use your financial data to understand what it tells you about your business.

Accountant or CPA

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.

In short: CPAs use their expertise and an analysis of your finances to help you leverage your business through loans and investments and ultimately build a financial plan for the future.

What is Law Firm Accounting Software?

It's no secret that accounting is tedious. The bad news? You can't use Excel spreadsheets to maintain all of your financial books and records for an entire year. When used for that much data, Excel becomes clunky and lacks features you could use to improve your reporting. The good news? There are plenty of tools available that can help get you started.

Keeping accurate records of your law firm's accounts is a challenging yet vital part of running a legal practice. Legal accounting software simplifies your firm's accounting and bookkeeping workflows— making it easier to stay compliant with ethics rules, protect sensitive client information, and effectively monitor your day-to-day cash flow.

The advantages of legal accounting software multiply with today's cloud-based solutions. While on-premise accounting software ties you to a physical location and requires high maintenance costs and time-consuming updates, cloud-based accounting software is accessible anywhere. Cloud-based accounting software for law firms also automatically gets updated and backed up, offering unparalleled, real-time insights into your firm's financial data.

How to Choose the Right Law Firm Accounting Software

Before purchasing software or a tool, ensure it fits your needs. A solid law firm accounting software should include features such as:

  • Billing and invoicing
  • Bookkeeping
  • Reporting and analytics
  • Expense tracking
  • Payroll
  • Tax prep

To keep things even more streamlined, consider using online payment software together with legal accounting software. For example, if you were using LawPay to collect payments and invoice clients, you could easily sync all your transactions into QuickBooks for easy reporting and reconciliation.

Do you use practice management software? If you don't, you should. In fact, some bookkeeping tools integrate with your practice management tools, allowing you to easily track your clients, invoices, and more. Make sure whatever tool you use integrates, or choose an all-in-one software for both.

Choosing various software that works together seamlessly makes running your firm much more straightforward.

Law Firm Accounting: In Conclusion

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.

Improve-Accounts-Receivable-Collections-600x200-Body-07-DemoCTA

From sending payment requests and tracking them to integrating with your go-to legal software products, LawPay will fit your needs. LawPay also ensures your law firm accepts payments that comply with your state bar's regulations surrounding trust (IOLTA) accounts and the American Bar Association (ABA) guidelines.

To learn more about LawPay can help your firm and how you can avoid legal accounting mistakes, schedule a demo today.