Why is legal bookkeeping so important?
While it is obvious that you should care about your law firm accounting, is the reason why and how much clear to you?
Just like any other business, effective legal bookkeeping is an essential and critical part of your “business”. Consider legal bookkeeping as the recipe. You sit down and enjoy a good meal, but there was a recipe that went into preparing that good meal. It did not just appear! Good recipes bring satisfaction.
So now, that you have a good “recipe” and satisfaction, what results does that bring? It brings you knowledge and insights necessary to make the everyday financial decisions for your business. So now let’s take a deeper look at the insights and knowledge you will gain.
Compliance: While the ethics rules will vary by state, one thing that is consistent amongst state is Compliance with regard to holding funds in trust. Failure to follow trust fund compliance, whether intention or negligently, can result in harsh penalties, or even worse possible suspension or disbarment. Is it worth the risk?
Growth: A law firm is just like any other business where Profit and Growth matters. Proper bookkeeping gives you the insight you need into your financials. You need to know what is coming in and what is going out to make good sound financial decisions. You need to know what your collection rate is. Do you practice in multiple areas? Do you know which areas of law are most profitable to your firm? While you chose a legal career because you are passionate about the law, you started your own law firm because you are also passionate about profit and growth.
Results. Understanding your profits allows for growth. A good legal bookkeeping system provides this for you so that you obtain Results.
Things you need to be understand and be aware of for your law firm are:
- Chart of Accounts
- Double Entry Accounting
- IOLTA (Interest on Lawyers Trust Accounts)
- Trust Accounting
- 3-Way Reconciliation
Chart of Accounts: This is the list of all your firm’s financial accounts (not just bank accounts). It includes your bank accounts, income accounts, liability accounts, asset accounts, equity accounts and expense accounts. All of these together make up your financial accounting.
Double-Entry Accounting: This is the backbone of bookkeeping where every entry requires an opposing entry. Every financial transaction has specific categories and will correspond to the Chart of Accounts. For example, your legal fee income – when entered to accounting it needs a second entry (which is the double entry). In this case, that would be where did the legal fee income go? Most likely your bank account. Therefore, your double-sided entry would be as follows: Increase Income Account / Increase Bank Account.
IOLTA (Interest on Lawyers Trust Account): While IOLTA rules will vary by state – the premise behind IOLTA remains the same – this is not your money. This account is specifically designed to keep client funds separate from the firm’s funds. In addition, attorneys are not allowed to collect interest earned on client trust funds. While every state will vary, most states take this interest and give it to the State Bar for use in social justice programs. There are some exceptions (such as paying interest to the client, but that is a topic for another day).
Trust Accounting: This is the area where I see most law firms make their mistakes. It is essential that any unearned fees reside within the Trust Account until they are earned and/or disbursed. These funds should always be kept separate from the firm’s operating funds and tracked accordingly.
3-Way Reconciliation: This is probably a term many lawyers are not familiar with and most often overlooked. However, it has extreme importance. 3 Way Reconciliation is done by comparing the IOLTA bank account reconciliation against a Trust Reconciliation and against the Client Trust Ledger. All three of these need to balance together in order to achieve a 3-way reconciliation. This ensures every trust penny is tracked and distributed as required by law.