In the fast-paced world of law, managing the financial intricacies of a practice can often feel like being cross-examined by a particularly aggressive opposing counsel. In other words, stressful.
But just like you can’t disregard questions from the opposition, you can’t ignore accounting either. Your law firm’s accounting isn’t an optional activity: it’s vital to your firm’s success, profitability, and good reputation.
The good news is that whether you’re a seasoned attorney or just starting out in the field, there are six essential accounting concepts that can help you create effective practices for your firm. So sit back, grab a cup of coffee, and let’s turn those concepts into your firm’s allies.
Concept #1: Generally Accepted Accounting Principles (GAAP)
Many law firms rely on GAAP, otherwise known as the Generally Accepted Accounting Principles, as a foundation for their financial accounting framework and financial statement generation.
GAAP is a set of universal accounting norms, standards, and procedures. These principles aren’t industry-specific—they broadly apply to any business to ensure comprehensive and comparable financial reports. Consistent accounting and record-keeping practices provide protection for lawyers and their firms in case of IRS audits.
Depending on the size of your firm, you may have an accountant that manages GAAP-related matters for tax filing and other accounting needs. Nonetheless, understanding the basics can enhance your collaboration with your accountant, benefiting your firm and its employees.
Concept #2: Accounting methods
Accounting isn’t just about tallying up your firm’s numbers at the end of the month. Accounting provides insight into the financial health of the organization.
What’s more, there’s not just one way to handle your accounting. Here are three popular methods of accounting:
- Cash basis: the simplest method, which logs revenue when it’s received rather than when services are rendered
- Accrual basis: records income when it’s billed instead of when payment is received
- Modified cash basis: hybrid model that uses cash basis accounting for daily bookkeeping and accrual basis for long-term expenses
There’s no one right answer to which method to use; each law firm has its own needs to consider when making this decision. However, it’s important to stick with a method once you’ve chosen it rather than switching between methodologies.
Concept #3: General ledger
Get familiar with your general ledger, because it’s fundamental to your law firm’s accounting. A comprehensive log of all your firm’s transactions, your general ledger breaks down transactions into types, such as assets, liabilities, revenues, expenses, and owner’s equity.
This information is used to create accurate financial statements. It’s also the basis of your double-entry bookkeeping system, documenting both the source and destination of funds.
If your law firm uses a bookkeeper, they will manage the daily financial tasks associated with your general ledger. Nonetheless, keeping an eye on your firm’s financial status is crucial for your own awareness and decision-making.
Concept #4: Financial statements
Financial statements provide detailed insights into your firm’s current financial position, financial history, and future prospects. There are three essential financial statements that lawyers should be familiar with:
- Income statement: shows the performance of your law firm over a specific period
- Balance sheet: shows your firm’s assets, liabilities, and owner/shareholder equity at a certain point
- Cash flow statement: shows how much money is coming in and out of your firm over a specific period
Concept #5: Trust accounting
Trust accounting is one of the most crucial aspects of legal accounting. Funds held ‘in trust’ for clients must be managed with the highest degree of care and transparency to avoid potential ethical or legal violations.
Compliance in trust accounting requires numerous safeguards, including:
- Maintaining separate trust accounts for each client
- Avoiding commingling trust funds with the firm’s operating funds
- Recording all transactions related to these accounts
- Regular audits and three-way reconciliation
Each state has its own trust accounting requirements that law firms must take into consideration, which adds to the complexity of trust accounting. For this reason, you’ll want to stay up-to-date on your bar association rules.
With legal practice management software with built-in trust accounting, however, critical tasks involving trust accounting can be streamlined and automated. This reduces the risk of errors and supports compliance with ethical and legal standards. But remember: trust accounting compliance is not solely about managing your firm’s finances. Trust accounting practices help you build trust with clients and maintain confidence in the services you provide.
Concept #6: Matter costs
Matter costs can feel abstract, but they’re an integral part of your law firm’s financial (and therefore, accounting) landscape.
Matter costs run the gamut from court fees to travel expenses to document processing charges—and understanding and tracking them is critical for several reasons.
Matter costs reflect matter profitability
Just because you work hard on a case doesn’t make it profitable. You may bill lots of hours, but if you have lots of related expenses, your net profit might not be worth the energy and resources. When you analyze the matter costs, you can make data-driven decisions about your firm’s services, which clients you take, and how much resources you allocate to them.
Understanding matter costs allows you to bill better
When you track matter costs precisely, you can establish appropriate fee structures for your costs. This allows your firm to maintain profitability, but also tailor payment options to clients’ needs when appropriate. For example, your firm may choose to offer estate planning services as a package due to the generally predictable costs and time required to complete the work.
Tracking matter costs can be complex, but using legal practice management software can reduce the effort involved. Law firms can use this software to automate tracking and allocating matter costs, which helps ensure accuracy, promote efficiency, and informed management decision-making.
Simplify law firm accounting with CosmoLex
CosmoLex is a comprehensive, legal-specific practice management software that offers robust built-in accounting tools designed for law firms. By integrating trust accounting, business accounting, and other financial aspects seamlessly with practice management tools, it becomes easier to track, manage, and stay in compliance without jeopardizing profitability or client service.
Take the first step towards a more efficient future. Sign up for a demo or start a free trial of CosmoLex today. Discover first-hand how our software can streamline your financial operations and set your law firm up for success.