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Accounting for law firms

ACCOUNTING AND FINANCIAL PLANNING FOR LAW FIRMS

With the financial pressures on small law firms in today’s highly competitive marketplace, comprehensive and accurate financial reporting systems are essential for your firm’s long-term success and stability.

The American Bar Association (ABA) reports that there are currently more than 1.3 million active attorneys practicing law in the United States. The vast majority of U.S. legal services are provided by solo practitioners and small firms with fewer than 30 attorneys. This means your firm likely has a lot of competition.

In recent years, clients generally have conceded to paying their attorneys higher billing rates, helping firms absorb rising operating costs. However, declining realization percentages have cut into law firm profits. If clients resist further rate hikes, firms may need to find alternative solutions — such as improving operational efficiency and cutting costs — to maintain future profitability.

Accurate, timely financial data can help you make the business decisions necessary to address these issues and not just survive but thrive.

SMALL LAW FIRM ACCOUNTING

Small, solo, and general practice law firms face unique operational and financial challenges.

A recent report from the ABA and the Thomson Reuters Institute shows that attorneys at small firms spend about 20% of their time on administrative and firm management tasks. These chores detract from billable activities and the pursuit of new business. In fact, the perennial top challenge reported by small firm attorneys is spending too much time on administrative tasks — and not enough time practicing law.

Small firms often lack comprehensive in-house accounting expertise, and many turn to external specialists for help with their unique operational and financial reporting challenges. That’s where Padgett Advisors comes into play. We specialize in providing accounting services for small law firms. We can help manage the financial side of your firm, allowing you to focus on practicing law and building your book of business.

LAW FIRM ACCOUNTING

Among other things, a well-designed law firm accounting process can help you:

  • Make informed business decisions;
  • Maximize profitability;
  • Manage client payments and trust accounting; and
  • Comply with applicable state bar association rules.

Accurate, timely accounting information can help lawyers monitor cash flow and collections, manage the nuances of client trust/Interest on Lawyers Trust Accounts (IOLTA) accounts, identify areas where costs can be reduced, and plan for the future, including wealth building and exit planning.

The specialists at Padgett have years of experience providing high-quality accounting services for law firms including:

Outsourced bookkeeping

Bookkeeping tasks can be time-consuming for your office staff. Our law firm bookkeeping specialists can handle these administrative chores directly for you on a weekly or monthly basis — or temporarily if your existing office manager unexpectedly leaves the firm.

The use of a trusted specialist in law firm accounting gives you the peace of mind of knowing that transactions will be recorded in the appropriate accounts with detailed, accurate descriptions. This can alleviate headaches when it’s time to prepare your year-end financial statements, income tax returns, and K-1 forms, if your firm operates as a general or limited liability partnership or a limited liability company.

Client trust/IOLTA account management

Law firm accounting requires an in-depth understanding of how to manage funds held on behalf of clients in trust or IOLTA accounts. Rule 1.15 of the ABA’s Model Rules of Professional Conduct provides guidance for holding funds in trust, recordkeeping, and notifying clients of the receipt of funds or property. Law schools don’t teach attorneys how to manage these accounts, and the rules vary from state to state.

Every transaction in and out of these accounts must be properly recorded and documented. Mishandling trust/IOLTA accounts or reporting them incorrectly can lead to serious repercussions, including penalties, suspensions, and even disbarment. So it’s important to get it right. We can help you maintain an accurate client trust ledger, track client-related costs, reconcile account balances, and generate trust/IOLTA accounting reports that comply with the rules in your state.

Preparation of monthly and year-end financial statements

Comprehensive financial statements include three reports 1) the income statement, 2) the balance sheet, and 3) the statement of cash flows. These provide an overview of your firm’s financial health.

We can issue financial statements for your law firm that comply with U.S. Generally Accepted Accounting Principles. Alternatively, some small firms may prefer to issue cash-basis or tax-basis financial statements. We can help you determine what’s appropriate for your current situation.

Interim operating reports

Year-end financial reporting isn’t enough for most firms. Effective law firm accounting requires analyzing financial performance on a regular basis to maximize profits and identify operating inefficiencies. Interim reporting can also help you identify the need for a line of credit to temporarily cover operating expenses while you’re waiting to receive payments from clients and case settlements. We can identify key metrics to help attorneys monitor financial performance on a real-time basis using weekly or monthly flash reports.

Common law firm accounting and operating metrics include:

  • Revenue/billable hours/profits per attorney;
  • Revenue/billable hours/profits per specialty practice (if applicable);
  • Travel and marketing expenses per attorney;
  • Case win rates;
  • Realization as a percentage of revenue/negotiated rates;
  • Paralegal and support staff utilization/turnover rates;
  • Client turnover and revenue/profit per client;
  • Cash, credit card, and electronic funds transfer (EFT) deposits;
  • Operating and trust/IOLTA account balances;
  • Receivables aging schedules; and
  • Capital/debt per equity partner.

Budgets and forecasting

Historical financial results may be used to project how your law firm will perform in the future. We can prepare budgets and forecasts to help determine whether you have the office space, technology, equipment, and staffing to meet future demand, as well as identify competitive threats and growth opportunities in your local market. These reports can also be useful when applying for bank loans or merging with another firm.

Throughout the year, we can compare your actual results to your budget. This analysis can ensure your monthly billings and expenditures stay on track. Major deviations may require revisions to your original budget or corrective actions. It’s always better to find out this information early, rather than to wait until year end!

Pricing models and billing rates

Law firms use a variety of pricing models. Beyond traditional hourly rates, law firms may charge flat, value-based, sliding-scale, and contingency fees. Some firms even offer legal subscription plans that offer certain services to clients for a fixed, recurring fee.

We can help you select the optimal pricing model for specialty practices and develop competitive billing rates. What’s appropriate depends on how your firm operates and how much other firms in your practice specialty and/or geographic markets are currently charging.

Compensation planning

Law firms often use complex formulas to determine attorney compensation. Compensation may vary based on revenue allocations between who generated the lead and who performed the work. There may be a merit-based component, too. Equity partners may get a share of the firm’s profits.

Moving up the ranks at a law firm usually require a lot of sweat equity. Increasingly, younger associates are leaving law firms for less-demanding positions with better work-life balances. This trend has caused some established firms to revise their compensation models to remain competitive in today’s tight labor market. We can help devise compensation plans for equity partners, other attorneys and support staff that will best achieve your firm’s goals.

Financial benchmarking

The purpose of accounting for law firms should extend beyond compliance with lending, tax and state bar reporting requirements. Most firms want to know how they measure up against competitors.

We can provide industry benchmarking data, based on your location, size, and specialties, such as those provided by the ABA, state bar associations and practice specialty groups. These benchmarks can be compared to your financial results to determine operational strengths and areas for improvement. Benchmarking can also help you evaluate your firm’s workflow, operating costs, pricing model, and the competitiveness of your compensation programs.

Accounting software selection

Effective bookkeeping and accounting for law firms requires more than Excel spreadsheets. Technology is a costly, but necessary, expenditure for law firms at they aim to improve efficiency and lower costs.

Over the last two years, 42% of small firms have adopted new technologies, such as timekeeping, document and case management, legal research, and e-billing/invoicing software; CRM platforms; and cloud-based storage solutions, according to a recent ABA/Thomson Reuters Institute survey. We can help evaluate these investments, including which tax breaks may be available.

Your firm needs specialized accounting software to track such items as:

  • Revenue/profits per attorney;
  • Revenue/profits per specialty practice;
  • Revenue/profits per client;
  • Operating and trust/IOLTA accounts;
  • Cash, credit card, and EFT deposits;
  • Accounts receivables and write-offs;
  • Accounts payable;
  • Attorney compensation;
  • Attorney expense reporting and credit card accounts;
  • Professional development and CLE costs;
  • Staff wages, benefits, and payroll taxes;
  • Rent, marketing, insurance, office supplies, and other overhead expenses;
  • Legal software, equipment, leasehold improvements, and depreciation expense;
  • Payments to and from equity partners;
  • Credit lines, commercial loans, and interest expense; and
  • Tax-related information.

Security is another vital consideration when selecting accounting software. Hacked or stolen client personal and billing records can lead to financial losses and harm to your firm’s reputation.

There are several bookkeeping and accounting solutions for law firms that vary in capabilities and cost. We can help you select a program that’s appropriate based on your size and specialty.

If you already have accounting software in place, it may be time to review it. For example, software that you selected when your firm opened may no longer be appropriate or a new product may have become available that’s a better fit for your current needs. We can help you assess your current software and evaluate alternatives to ensure you’re utilizing accounting software to its full potential.

We encourage you to contact us with any questions.

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