Top 4 Accounting Challenges Facing Law Firms Today

Legal accounting has always been a challenge – but there are a few that top the list for lawyers today. 

Accounting can be tough on a good day in any industry, but lawyers have some particularly unique factors to take into consideration. Not only is there the traditional business accounting aspect, like dealing with payroll, office purchases, profit and loss statements, and balance sheets, but there’s also matter costs and income allocation. On top of all that, lawyers also have to be mindful of retainers, fee advances, and trusts. 

Even with a busy schedule, client demands, and staff management, lawyers still need to be watchful to make sure their accounting is handled properly. Inaccurate accounting can be cause for an ethics violation, but it can also drive down profits if done incorrectly. 

As they say though, “the best offense is a good defense.” And in this case, that means knowing what the challenges are and tackling them head on. 

Posting revenue incorrectly 

Most businesses take in an invoice payment as a single deposit and that’s it – it simply gets deposited into the account and is later associated to a chart of accounts and used to determine tax liability. For law firms though, there’s a lot of other items that payment must be applied to first to make sure all costs and liabilities are covered first. 

If you’re taking in a payment, be sure you apply it in the following order:

  • Sales tax payable
  • Advanced client costs
  • Recoverable client costs – hard costs
  • Recoverable client costs – soft costs
  • Finance charges and late fees
  • Fee income

This is often where it’s helpful to be using legal-specific billing software. Tools meant for general use, like QuickBooks, don’t come with this feature built-in, which often means income is recorded but not allocated appropriately. 

Failing to properly recover costs

The amount of money that can be spent on a client matter can add up quickly. If you’re not recovering these costs, that means you’re out the money – and your profits are going to take a substantial hit. To keep the money within the firm, it needs to be properly billed to the client. 

The best way to make sure you get paid for everything? Record your time and costs as they happen. If you’re using a practice management program, they likely have an app you can use or you could always use a paper and pen if it came down to it. 

Remember: if you don’t track it, it won’t be billed. And what’s not billed doesn’t get paid. 

Another area that winds up presenting issues for law firms is making sure any costs are properly designated. This step is critical, as not all costs are recoverable. As you’re recording, costs need to be assigned as either hard (expenses that are normally related to vendors, like court reporting charges) or soft costs (expenses that can be more difficult to pass along and are often related to general overhead, like copy charges). 

Decide ahead of time what category particular costs belong in to make it easy to determine which category to apply it to. Depending on your accounting software, you may be able to set it up so it automatically assigns particular costs to a certain cost type. 

Mishandling of client funds

There’s a good reason why trust compliance is so strict – you’re handling your client’s money. Until it’s deemed “earned”,  it needs to be tracked and managed down to the penny.

Third-party disbursements, invoice payments from trust retainers and third party liens and bills all have a role within trust funds. There’s a lot to keep track of and there’s a number of problems firms run into: 

  • Lack of trust-specific knowledge and rules
  • Relying on manual systems
  • Trust funds wind up commingled with firm funds
  • Absence of safeguards results in errors
  • Uncleared funds aren’t addressed
  • Messy bank reconciliations
  • Separate billing and accounting requires double data entry

To correct all of these, there’s no simple fix or singular workflow change that can address them. However, this is another scenario where legal-specific software can make all the difference, especially if they have integrated billing and accounting. Having a tool that’s built for legal means it comes with all of the features needed to handle trust accounting, including mechanisms to prevent you from making mistakes and one-click buttons to generate reports and handle reconciliations. 

Not making decisions based on data

Gut feelings have their place, but when it comes to making business decisions, you need data to get the best results. Law firms are still businesses – and that means informed decision-making is a must. That means accounting isn’t just about compliance, but also about accurately tracking the financial data of your firm so you can make informed choices. 

Here’s some of the data points law firms should be paying attention to:

  • Revenue by practice area and individual
  • Overall financial trends
  • Utilization and realization rates
  • Accounts receivable by aging

Check out more of what you should be using to make decisions: 10 Metrics Law Firms Should Track

Be proactive in making sure you’re ready to take on these challenges. Staying on top of your law firm’s accounting is much easier when you’re informed about what you’re up against – and when you have the right tools.

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