No matter which industry you’re in, having a clear view of your finances is essential. Every business needs to understand its cash flow, keep track of its assets and liabilities, and identify the most profitable areas of its organization. However, while accounting matters to the success of every business, law firm accounting is particularly important.
Compliance and trust are at the heart of the legal industry. This not only raises the bar when it comes to accounting regulations but also makes law firm accounting more complex than accounting across other sectors. In this guide, we’ll explore what makes legal accounting unique, and dive into the 20 best practices for law firm financial management in 2024.
While basic accounting rules still apply, law firm accounting comes with additional considerations. Law practices don’t just manage their own finances, they also routinely handle financial matters for others. An attorney might have to manage the performance of a trust fund or estate or make disbursements from a client’s fund (for example, to pay for third-party professional services or medical care). As a result, they are required to open dedicated trust accounts and are subject to strict accounting rules to ensure proper safeguarding of clients’ money and assets.
The day-to-day business of running a law firm adds further layers of complexity. Most law practices use billable hours to charge clients for time spent on a project, as well as retainer agreements for ongoing services. Both of these models require scrupulous bookkeeping to ensure fair and accurate invoicing for clients and optimal allocation of practice resources.
The structure of a law firm also matters when developing its accounting best practices. Most law practices are limited liability partnerships (LLPs), where senior lawyers are partners in the firm. Their liability is limited to the amount of money that they put into the business. Because they are partners as opposed to employees, there are tax implications around partner compensation that must be taken into account.
A key pillar of law firm bookkeeping is double-entry accounting. When law firms hold property on behalf of a client, it’s essential that they hold the asset in a separate bank account and ensure that there is no commingling of funds. Double-entry accounting ensures a clear separation between the firm’s financial transactions and any transactions undertaken on behalf of its clients. With this system, every accounting entry is recorded in both the firm’s and their clients’ accounts, and it goes without saying that the books need to be balanced.
Three-way reconciliation is essential to ensuring accuracy and compliance in your law firm’s accounting. This process involves comparing three elements:
It’s crucial to perform this reconciliation regularly and to make sure that all three balances match up.
An IOLTA (Interest on Lawyer Trust Account) is a trust account used by legal professionals to handle unearned funds that belong to their clients, like retainers or any court fees that need to be paid to progress their case. Often, the amount of money flowing through an individual client’s trust account is not enough to generate a significant amount of interest on its own. However, lawyers are allowed to pool their clients’ funds into an IOLTA. The interest on these accounts is sent to the state bar for charitable purposes, such as funding legal assistance for low-income clients.
As we’ve seen, law firm accounting often involves managing clients’ funds, with client funds held in a separate trust account. Trust accounting is the process of managing these trust accounts in line with legal and ethical obligations. In particular, law firms must be careful not to co-mingle their clients’ funds with their own business finances. Lawyers are also obliged to maintain diligent and accurate records of the trust account.
The unique considerations of law firm accounting, such as billable hours and trust accounts, make it cumbersome and time-consuming to manage manually. It’s also high risk, as even an innocent mistake can lead to a penalty or a loss of license. Accounting software can be extremely useful in avoiding these issues. The latest platforms are designed to automate many law firm accounting tasks, from generating reports to performing reconciliations. Automation reduces the risk of human error, streamlines operations, and helps to ensure compliance with regulations.
One of the key principles of law firm financial management is maintaining separate accounts for client funds in order to segregate them from your law firm’s bank accounts. This is explained in the Model Rules of Professional Conduct of the American Bar Association. Rule 1.15 (Safeguarding Property) states that: “Funds shall be kept in a separate account maintained in the state where the lawyer's office is situated, or elsewhere with the consent of the client or third person.”
Effective law firm bookkeeping is built on regular check-ins to provide a clear picture of your finances and ensure accuracy and compliance. Therefore, it’s essential to reconcile bank accounts on a regular basis and check that your recorded transactions match the financial statements. That way, you can catch any errors as they arise to maintain the integrity of your accounts.
Accurate tracking of billable hours is crucial. Not only will you foster trust and transparency with your clients by reassuring them that you’re billing them fairly, but you’ll also be able to effectively identify the most profitable areas of your business. Best practices for tracking billable hours include:
A chart of accounts is an organizational tool that helps you build a clear picture of your law firm’s financial health. A chart of accounts assigns a number to every single account or type of transaction used in your business, and typically includes these five categories:
However, it’s essential to use a chart of accounts that can handle the industry's unique complexities, such as trust accounts or retainers. For example, under “Assets,” you’d need to include client costs that have been paid in advance but not yet spent.
As a lawyer, you have a duty to monitor client trust accounts closely. Review all activity, make sure you understand every transaction and compare the reconciliation reports against the bank statements on a regular basis to ensure that everything matches up.
There are strict regulations governing IOLTA accounts, and a risk of penalties (or even being disbarred) if you fail to comply. Therefore, it’s essential to adopt best practices to ensure compliance. Invest in training for financial and accounting staff so that they fully understand IOLTA regulations, keep client and business accounts separate, and never “borrow” from an IOLTA account by withdrawing money before you have earned it.
Attorneys have to pay various expenses for both day-to-day operations and on behalf of clients. If you’re doing this manually, it can be challenging to record these accurately and maintain strict segregation between operational and client expenses. But by automating your expense tracking with a specifically designed software platform, you can streamline this process and eliminate the risk of human error.
Nobody likes nasty surprises, and nobody appreciates an unexpected invoice packed with undecipherable services and additional charges. To foster good relationships with your clients, it’s best practice to adopt a clear invoicing and billing process. Take the time to set expectations with new clients, stick to a consistent schedule, and agree on charges in writing first. Finally, make your invoices as clear as possible, with accurate descriptions for each billed item.
Just like any other business, your law firm will benefit if you follow a strict budgeting process. Set time aside every month to review your budget, and compare your forecast to your actual figures so that you can understand your performance and proactively make changes to keep your finances on track.
In addition to keeping you on the right side of financial rules and regulations, proper law firm accounting can help you grow your practice. Regular financial analysis will reveal if your firm’s KPIs are being met, help you identify your most profitable activities, and highlight areas of concern to help you plan for the future.
Your financial records are the backbone of everything you do. Keeping meticulous records helps maintain your integrity and streamline operations, making it easy to pull together client updates or mandatory reports. Record every transaction, from day-to-day expenses to one-off disbursements, so that you always have the correct figures on hand.
Tax considerations loom large in law firm financial management, whether for your business, your partners and employees, or your client trust accounts. Note any filing and payment deadlines so that you don’t rack up late payment penalties. Keep funds in reserve to pay any tax bills. Conduct regular reviews to ensure you’re staying compliant and optimizing your operations for maximum tax efficiency.
As with any business, managing cash flow is critical to your accounting. You’ll need to ensure you have enough funds to cover outgoings such as office rent, employee salaries, and other expenses. This also applies to any funds you manage on behalf of clients: It’s essential to manage the cash flow of your client trust accounts. Similarly, always ensure that these accounts have sufficient funds to cover clients’ costs so that you’re never tempted to borrow from one account to ease cash flow in another.
Another key pillar of law firm accounting is ensuring ethical billing practices. The ABA states that “a lawyer shall not make an agreement for, charge, or collect an unreasonable fee or an unreasonable amount for expenses” and lists eight factors to be considered. When it comes to billing, clarity is at the heart of best practice. Make sure that you accurately describe all the work you’ve performed for your clients so that they can clearly understand the rationale.
Ethical and legal compliance is critical to law firm accounting, so make sure that your staff have the skills and knowledge they need to succeed. Take the time to thoroughly onboard your accounting and finance staff, and invest in regular training to ensure that they understand their responsibilities, are up to speed on any regulatory developments, and feel confident using your accounting software.
Effective accounting can greatly enhance law firm productivity. By analyzing your practice’s financial performance, you can identify the most profitable areas of your business, spot your star performers, and highlight where you need to make improvements. Make sure that financial metrics are included in your law firm’s key performance indicators to guide informed decision-making.
Robust internal controls are essential to prevent fraud and help your law firm stay compliant. Firstly, you’ll need to establish controls to prevent the possibility of fraud, such as segregating duties so that no one person has control of all the firm’s financial management and implementing secure IT passwords and access permissions. Early detection is also critical. Regular checks and account reconciliations will help you identify any financial discrepancies and take appropriate action.
Conducting regular financial audits is good practice in any industry, and particularly important in law firm bookkeeping, where you might well be required to submit a mandatory auditory report as part of a case. Analyze your practice’s financial records on a regular basis to check for accuracy and safeguard against malpractice or mismanagement. You’ll be able to identify and tackle any discrepancies as they arise and identify any areas needing improvement.
The law doesn’t stand still, and neither does the world of accounting regulation. It’s important to stay abreast of any changes to the regulation landscape to ensure your law firm's accounting remains compliant and to avoid falling foul of any new laws. Subscribe to industry publications, follow thought leaders on social media, and invest in regular training for your team to ensure you’re all fully up to date.
While law firm accounting might seem complex when compared to other industries, adopting best practices will help you get it right. Law firm financial management software is a cornerstone of best accounting practice, helping you to streamline operations and keep compliant in a dynamic regulatory landscape.
Estateably is a cutting-edge software platform designed specifically for trust and estates professionals. This comprehensive solution puts document automation, reporting, and robust accounting at your fingertips, so you can build financial stability into your practice while confidently and effectively meeting your ethical obligations. Schedule a demo with our team to find out more.
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