Many lawyers make the same common mistakes when it comes to legal accounting. Mistakes that will make your accounting harder than it needs to be. However, a few small changes in how you handle your bookkeeping can simplify your entire experience. While accounting is certainly a difficult task, it becomes manageable when you take note of potential pitfalls and how to avoid them.
Common Legal Accounting Pitfalls
Each area of legal accounting (business accounting, matter cost/income accounting, and fee advances/retainer accounting), contains hidden pitfalls that can be time-consuming and costly to fix. Awareness and prevention will help you avoid complications and Bar Association compliance violations caused by some of the most common pitfalls:
1. Poor Handling of Client Funds
Acting as the fiduciary of client funds is a significant responsibility, one that comes with a large number of rules to conduct your role ethically and responsibly.
Where things go wrong: The volume of trust accounting rules can be difficult to remember as you complete your day-to-day transactions, leading to errors when accounts are maintained manually. Accidental commingling of funds, trust accounting ledger overdrafts, and failure to address uncleared funds can all occur without firm safeguards in place to prevent them.
2. Cost Recovery Challenges
The only way for a law firm to stay in business is to get paid by its legal clients; so it’s critical to make sure every billable item is being tracked and invoiced. Client expenses also need to be tracked to make sure advanced funds are reimbursed.
Where things go wrong: When expenses and billable time aren’t recorded in real-time, income can slip through the cracks. Expense tracking especially can prove to be an issue when trying to record entries from a variety of payment methods, including by check, credit card or cash. Even when tracked, costs are often incorrectly labeled when identifying them as either soft/indirect costs or hard/direct costs. Learn more about the proper identification of soft and hard costs in the article Tracking Indirect and Direct Costs.
For both expenses and billable hours, these entries provide little value if they’re not allocated to a particular matter. Without the association to a legal matter, the client will never actually be billed for the item.
3. Incorrect Income Posting
Recording income isn’t always as simple as recording an entry when a payment is received. Law firms have specific requirements in regards to the order in which income must be disbursed — with funds going toward liabilities first. Each of type of income requires its own specific entry into the accounting system.
Where things go wrong: Failure to allocate income appropriately can lead to accounting nightmares. Partial payments especially need to be applied in the correct order. Otherwise, the result is payment that is applied uniformly across all categories, creating earned income that doesn’t truly exist and liabilities left unaccounted for.
4. Missing Out on Data-Driven Decision Making
Every law firm is a business and for a business to be successful it needs accurate financial data to make sound business decisions.
Where things go wrong: Failure to collect and analyze your accounting data leaves you missing out on key information, like what practice areas and clients are bringing in the most revenue and what your biggest expenses are. Looking at these trends year-over-year can show where there’s an opportunity for growth and where cutbacks can be made.
5. Utilizing Separate, Generic Tools
Generic accounting tools can be powerful for many businesses, but often fail to meet the legal-specific needs and requirements unique to law firms. Even when using practice management tools built for the legal industry, most are not comprehensive enough to include billing and accounting meaning you still wind up using a generic program like QuickBooks™ along with it.
Where things go wrong: Separate tools means double data entry, additional costs and more room for errors and missed entries. In addition, many of the legal-specific accounting requirements we discussed earlier, like income distribution and trust accounting, fail to be correctly handled by general programs. For example, QuickBooks™ by default applies partial payments uniformly across the allocation categories, creating inaccurate income records.
How to Avoid Pitfalls
All of these legal accounting pitfalls can be addressed with a few key changes to your accounting process. Accounting errors are notorious for being hard to correct once a mistake is made, so stopping them before they occur is an excellent place to take action. The right processes and tools can go a long way to eliminating errors, so take care to avoid the general solutions that don’t have the tools needed to handle legal-specific tasks.
Using the right solution will limit the amount of time you spend dealing with transactions and entering them. The more time you spend on these tasks not only creates more possibility of errors, but takes away valuable time you could be devoting to billable hours and bringing in more revenue.
Ready to eliminate the bad habits that are making accounting difficult? Check out our free webinar 5 Legal Accounting Pitfalls and How to Avoid Them and find out the quickest ways to simplify your legal accounting processes.