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Chapter 4/6
Law Firm Finances
15 min read
Once you have a strategy and budget in place, the work of day-to-day management sets in. Reviewing your finances is not an annual event completed at tax time! You need to keep a pulse on your numbers to know if your business is healthy.
In this chapter, we’ll start with choosing accounting software. Next, we’ll discuss who needs to be on your financial team. With those items in place, we can tackle what to monitor and when. Finally, we’ll go over some common financial mistakes and how to avoid them.
Let’s face it: accounting is tedious work that makes our heads spin. Yet, there are plenty of tools available that can help get you started. You can’t simply use an Excel spreadsheet to maintain all of your financial books and records for an entire year. When used for that much data, it’s clunky and lacks features you could use to improve your reporting.
Before you purchase software or a tool, make sure it fits your needs. Over the years of trial and error, we know a solid law firm accounting software should include features such as:
Billing and invoicing
Bookkeeping
Reporting and analytics
Expense tracking
Payroll
Tax prep
The software you choose might also include a mileage tracker, the ability to offer online payments to your clients, timekeeping tools for tracking your time, bill payment, and the ability for multiple users to access the tools.
With all the options available, we know it’s difficult to choose which software is the best choice for your firm. After all, you have to sift through the options alone, convince your partners to agree, and pray that it works as it should. Talk about overwhelming.
To find the best fit:
At Lawyerist, we firmly believe in the benefits of automation for accounting and bookkeeping. That’s why we’ve taken it upon ourselves to review a wide range of tools for you, so you don’t have to. You’ll find more at our Accounting, Billing & Finance review portal.
Do you use practice management software? If you don’t, you should. In fact, some bookkeeping tools such as QuickBooks and Xero integrate with your practice management tool, allowing you to easily track your clients, invoices, and more. Make sure whatever tool you use integrates properly or choose an all-in-one software for both.
“For the first few years of my practice, I did my own taxes because with online software, how hard could it be?” – Stephanie
Stephanie soon discovered that even software can’t replace the benefits of hiring a professional:
“When things got complicated, I hired a CPA. They offered to look at the last few years of filings as a courtesy. Wow! They found some things I didn’t know about and ultimately filed amended returns, resulting in a nice refund check. Lawyers should take our own advice about representing ourselves and hire professionals.”
It’s a great idea to recruit help for your financial team. Let’s break down the different roles and the work they do.
First things first, bookkeeping and accounting aren’t the same things. Although they share a common goal, they occur at different stages of managing your firm’s finances. Bookkeeping happens first and relates to the administrative side of tracking your cash.
It involves:
Recording every financial transaction that occurs within your firm, such as posting debits and credits
Creating and sending invoices
Running payroll for your team
Bookkeeping requires you to be accurate, diligent, and display attention to detail. On the other hand, accounting is more subjective and involves:
Using your books to uncover business insights such as key performance indicators, financial trends, the impact of financial decisions, tax planning, forecasting, etc.
Capturing expenses not originally recorded and adjusting entries accordingly
Preparing financial statements and other reporting tools
Planning for tax liabilities
Completing tax returns
With those distinctions in mind, it becomes easier to see which type of professional help you might need.
“I waited six years to hire a bookkeeper—wish I’d only waited five minutes—so much benefit to outsourcing.” – Gary
As a solo attorney, managing your books via accounting software may get you started. Yet, if you own a small firm with multiple attorneys, employees, or contractors, hiring a bookkeeper is more than worth it.
A bookkeeper records the daily transactions of your firm. Remember earlier when we discussed setting up a Chart of Accounts in Chapter 1? Your bookkeeper goes into your accounting software regularly (at least weekly) and records all the money coming in and all the money going out so that it appears in the correct place.
In addition, your bookkeeper may ?help you process and send invoices, process your accounts payable, and run your payroll. Your bookkeeper can also run routine financial reports for you, including the income statement and balance sheet described in Chapter 1.
Bookkeepers offer many benefits:
Saves you time. We know all too well how some necessary tasks get pushed to the wayside while we juggle everything else. Yet, your bookkeeping shouldn’t be one of these tasks. A bookkeeper can take it off your hands.
Assists you with keeping your books updated. If you fall behind on bookkeeping, you won’t have an accurate overview of your finances. This can cause you to make decisions that result in serious consequences for your business. A bookkeeper keeps your books updated and even sends you reports periodically so you’re always in the know.
Uncovers useful business expenses. Bookkeepers capture and correctly categorize your expenses, finding useful ones you can use at tax time to lower your liability.
Many small firms find that outsourcing their bookkeeping functions is a great first step in delegating work off the owner’s plate.
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. Controllers have some financial data analysis skills. They can use your financial data to understand what it tells you about your business.
Many lawyers assume their bookkeeper can or should help them with their financial analysis and get frustrated when they don’t. Some bookkeepers may also ?wear this hat, but many will not. If you understand the different roles and skillsets each position has, you’ll be able to assess what type of help they can provide to you.
A Certified Public Accounts (CPAs) provides an in-depth analysis of your books, helping you to:
Secure credit the right way. CPAs use their expertise and an analysis of your finances to guide you in the right direction when you’re looking to secure a loan. For example, they can help you choose a loan type and size that’ll fit your bottom line in the best way.
Plan for the future. If you’re considering closing your firm or want to sell in the future, a CPA can educate you on your tax responsibility, your firm’s market value, and more to help guide your decision.
Invest with confidence. CPAs can also guide you towards investments that make the most sense for your firm’s future.
Prepare your business taxes—a feat that no one should ever attempt to do alone.
If nothing else, ?hire a CPA for your annual tax preparation. This is typically an annual expense and well worth it.
While you could hire permanent accounting help as your firm grows, most firms find working with an independent contractor who provides these services is a great way to get started.
If you do plan to hire professional help, there are a couple of things to keep in mind. Each firm is different, and your firm has unique circumstances that affect how you move forward. Here are some questions to answer:
Will they use your technology and procedures, or will you use theirs? Is the person certified in that software program?
What tasks will your bookkeeper do and how frequently?
How do you prevent fraud?
Are you confident your bookkeeper will manage your IOLTA accounting?
In today’s world, it is easy to find and use a virtual bookkeeping service. Also, many outsourced companies are now offering a team approach where you get the benefit of their bookkeeper, controller, and outsourced CFO for higher-level financial analysis.
We know that lazy bookkeeping practices will cost you real money and time, result in sweaty nightmares, and put your license and firm at risk. Thankfully, good bookkeeping can also result in accurate reports on demand, make billing easier and improve the way you view your finances.
By now, you know you can’t simply create a financial strategy and budget and sit back and relax. You must actively manage your finances. Using key performance indicators will help you know sooner if you’re on track.
First, let’s review typical accounting and bookkeeping functions that need to happen regularly so you can make sure you’ve got these covered.
Here’s a breakdown of common financial tasks:
Weekly
Record payments you receive; deposit cash and checks
Review and reconcile transactions
Review employee timesheets
Process payroll for weeks with payroll (and pay yourself)
Review and manage Accounts Receivable
Review account balances, cash requirements, and projected cash flow
Monthly
Invoice clients (at least monthly)
Pay vendors or schedule bills to be paid
Reconcile all accounts
Track budget and variances
Review and analyze financial reports
Backup your data (if you’re not using software that does so automatically)
Transfer a percentage of revenue into a tax account
Quarterly
Review financial statements for the quarter (compare with last quarter and with projections and goals)
Review 1099s for quarter
Make estimated tax payment
Evaluate financial goals and long-term strategy
Annual
Prepare year-end financial statements
Prepare year-end tax returns
Update financial strategy and plan for larger investments
You’re all set to monitor your financial reports. Congratulations!
Before you get too overwhelmed with numbers, let’s take a step back and make it super easy. What 4-6 numbers could you look at right now to determine your firm’s financial health?
Stay focused on these. It is easier to monitor and manage a few numbers. It will be much easier to pick a few numbers and keep those top of mind.
Here are a few to consider to get you started:
Profit and Profit Margin – How much profit are you generating as a percentage of your total revenue? The target should be 10-15% with all partners being paid market rate as an expense item.
A/R over 30 days – How many clients owe you money and how much do they owe you? Target should be 0.
Cash On Hand – How much cash and credit do you have available in non-client (i.e., not trust) accounts to keep your business afloat? The target should be 30-90 days of operating expenses.
Realization Rate (Collected Fees) – How much money are you collecting as a percentage of fees you are invoicing? The target should be greater than 95%.
Labor Percentage – How much are you spending on labor (employees’ salaries, taxes, and benefits) as a percentage of total revenue? The target should be 30-33%.
For more on financial KPIs for your law firm, listen to the Lawyerist Podcast, episode #266: 5 Financial Key Performance Indicators for Your Firm, with Stephanie Everett
Go Deeper: Podcast Episode #266
5 Financial Key Performance Indicators for Your Firm, with Stephanie Everett
Listen to EpisodeYou may find that your initial projections were wildly off. It happens! The key is to actively monitor things so you know when and what to adjust. If you’re missing your budgeted numbers, you can reduce expenses, delay one time purchases, increase sales through more aggressive marketing or advertising, or lower your profit expectations. When you know and monitor your numbers, you can quickly see when you’re off target and cut costs or make strategic investments to increase revenue.
As your budget year crawls on, you can adjust numbers to more accurately reflect reality and plan the rest of the year accordingly. Trending significantly ahead? See what strategic opportunities you have for reinvestment and plug those into your budget. If you’re trending behind, it is better to know sooner rather than later so you can react accordingly.
Your financial strategy will help you plan, strategize, and shift as you need to, helping you grow a financially healthy law firm. Each month, take some time to reconcile your budget compared to your reality, making changes that benefit your bottom line. And don’t worry—you’ll get better with practice.
As owners of our own law firms, we’ve made our fair share of mistakes. Unfortunately, bookkeeping mistakes have consequences for your business, income taxes, and license. The good news is that these mistakes are easy to avoid. We’ll show you a few common ones to keep in mind.
Anyone wanting to run a legit business should never combine personal and business expenses. After all, it’s also frowned upon by the IRS. Intermingling the two makes it nearly impossible to claim your expenses, not to mention track the financial wellness of your firm.
To ensure you don’t intermingle, keep separate accounts for your business and your personal finances. For bookkeeping purposes, ensure you’re only tracking transactions that occur within your law firm’s accounts. If for any reason you make a mistake (such as depositing a personal check in your business account), make sure to track it in your books.
Speaking of expenses, one of the most common mistakes attorneys make is losing track of business expenses. It’s best to capture and record your business expenses on the daily, so you don’t lose those receipts or invoices. Then, set aside a time each week to make sure they are coded properly in your books.
It’s also a great practice to record the details of each expense. For example, if you’re expensing a meal, you might record who you were with and what you discussed. After all, if the IRS audits you (shudder), you’ll want these records to prove your expenses were for business purposes.
Bookkeeping requires dedication and attention just like everything else in your firm. We understand what it’s like to have everything fall on your shoulders. That’s also why we recommend eventually hiring a professional bookkeeper to ensure nothing falls through the cracks.
Guess what? You can’t wait until right before tax time to start tracking your finances. In fact, you can’t even afford to wait a week until you make time to enter your transactions. We recommend scheduling a time to track your finances at least weekly.
Yes, put it on your calendar. It really is that important. A small amount of time each week will prevent you from spending hours on end trying to catch up.
Have you ever tried to balance your checkbook, only to find you’re a quarter off somewhere? One number mistake on your law firm’s books can cause pandemonium. That’s why it’s important to take your time, double-checking your entries as you go.
The only way to make it happen goes back to our previous point: don’t procrastinate. Take time each day to enter your numbers, taking the extra few minutes to double-check your work.
The goal of bookkeeping is to have an accurate picture of your current financial standing. Missing transactions cause inaccuracies that can cost you. For example, you might think you have plenty of money in the bank and buy a new computer before realizing you forgot to record that check to the court reporter. Yikes! A simple mistake could send your firm into the red for the month. Or, you might lose track of critical transactions that affect your taxes.
To avoid this type of situation, use accounting software that allows you to automate these processes. For example, keeping track of invoices or monthly recurring expenses. Again, you should also be spending time daily recording your firm’s transactions.
In accounting, there are two types: the cash method and the accrual method. In the cash method, you record transactions as the cash is exchanged, regardless of when the transaction takes place. In the accrual method, you record a transaction when it actually occurs.
We recommend choosing one or the other to prevent confusion and for the most accurate overview of your firm’s finances.
As an attorney, you’re aware that when you receive money that belongs to a client, you must place those funds in a trust account separate from your own money. These funds are stored in IOLTA or “interest on lawyers trust accounts” accounts.
You don’t have to struggle with IOLTA accounts. In fact, some basic rules dictate how you must handle this money to ensure compliance.
First, does the balance in your IOLTA trust bank account match the amount reflected on your books in the IOLTA trust liability account balance?
Next, does each client’s trust balance have a detailed ledger showing specific transactions for every single inflow and outflow?
Finally, when taken together, do the total amounts reflect in each client’s IOLTA trust account balance on your firm’s books add up to the balance in your IOLTA bank account?
Follow these rules and keep track of client funds every day to ensure you don’t cross any lines that can cause your firm serious problems.
In the end, numbers are fun! You’ll get excited to see your hard work pay off with tangible results in your bank account!
Download the Full Guide to Law Firm Finances
With this guide, you’ll understand key financial concepts, financial levers affecting your business, best practices for billing and collecting money, and how to manage and outsource financial work. And, you’ll have tools to tackle business insurance and taxes.
