Every business owner should maintain well-organized financial records, but for a law firm, the stakes are especially high. As in other industries, clean, detailed books help the law practice to thrive and grow. They allow owners to better understand their financial position and plan for the future and give banks and other potential lenders confidence in the firm’s reporting. However, as a heavily regulated profession, they are also essential to the basic functioning of the legal business.
Lawyers are unique among business owners in that they manage not only their own money but often their clients’ money as well. An error made in another company’s books, while unfortunate, would normally only mean a problem to straighten out at the end of the month or year, but making an error with clients’ money can cost the firm its professional reputation and may even cost the lawyer who made the error his license.
Acting as a custodian of others’ assets requires a higher level of trust and excellence. While this may seem like a good reason not to outsource your firm’s bookkeeping work, the opposite is true. Your clients come to you for your expertise; why shouldn’t you go to a financial expert for theirs? Lawyers have one of the most demanding professional schedules, and managing internal bookkeeping and accounting responsibilities on top of technical legal work is an easy way to ensure a higher degree of human error. Leaving the financial recording and reporting to an accountant will free you to better serve your clients in your personal area of expertise.
Client billings are a law firm’s lifeblood. If you do not have a streamlined, professional method of keeping up with invoicing and collections, your practice could miss out on a large amount of income. The 2018 Legal Trends Report estimated the loss of income due to inaccurate billings or failure to collect at up to 15% of actual billable hours. That’s a huge amount to write off as a loss! An accounting firm can consult with you to create a system that allows you to keep up with your billable hours, and make sure that your invoices are reaching your clients in a timely manner.
When tax time comes around, an accountant can also help you differentiate between your actual cash receipts and any uncollected invoices that may be reported as revenue, even though you have not actually received the funds. These are just a few examples of ways in which working with a trained professional can improve your financial reports and reduce your tax liability.
Trust And IOLTA Accounts
As previously discussed, lawyers often act as a custodian of their client’s money, generally due to retainers and settlement funds. This places the legal professional in a position of trust and causes ethical concerns to arise. To mediate any potential issues and allow attorneys to stay compliant with the rules that govern them, assets are stored in Trust and IOLTA accounts.
To reduce bad debts and ensure there is enough money on hand to pay for court costs, attorneys may require the client to pay a retainer, a remittance that the client makes to the professional before any work is performed. When a lawyer receives a retainer, the money must be kept separate from the operating funds of the business, in an account called a trust account. They are then used to cover motion fees, filing fees and other court expenses as they arise. Additionally, as the attorney performs his or her work and earns revenue, funds are transferred out of the trust account to the firm’s operating account.
In practice, one trust account is used, but the firm will keep a trust ledger and separate client ledgers that track “sub-accounts” for each individual client. These ledgers are subject to a three-way reconciliation with the bank statement every 1-2 months to ensure that accounts are being tracked properly.
Following this process, while detailed, proves useful. Since attorneys are not allowed to benefit from their clients’ money, keeping the assets in a trust account reduces the likelihood that ethical violations may arise. If a non-interest-bearing account is used, no interest is earned that could be kept by the firm, and if an interest-bearing account is used, it is easier to track what income is sourced to each individual client so that the money may be remitted to them. Additionally, since the funds are held separate from the operating account until earned, there is no chance that they could mistakenly be used to pay for business expenses. This also gives rise to a system of cross-checking reported balances to ensure accuracy.
As discussed, it is considered unethical for lawyers to earn interest from their clients’ money. For this reason, settlement funds, closing proceeds and other deposits received on their behalf were traditionally put into non-interest-bearing accounts as well. That is until the 1980’s when the American Bar Association spearheaded efforts to bring the use of IOLTA accounts into the American judicial system. IOLTA accounts are interest-bearing escrow accounts used in situations where the amount of funds is small, they will not be held long, and/or the cost of tracking the income tied to the assets would cost more than what would be earned.
This most commonly includes settlement funds and closing proceeds, which are quickly disbursed to clients. One pooled account is used for all clients, and the interest earned is forwarded by the bank to the state IOLTA program. It is then used to fund social justice initiatives, generally to provide legal services to those who could not otherwise afford it.
After learning about the expectations of lawyers regarding their books, it is easy to understand the benefits of working with a CPA. Ensuring proper accounting with the described requirements and movement of funds is complicated, and as the firm and client list grows, so too will the number of transactions to record. Consider the list of responsibilities a lawyer must manage during the workday – answering phone calls and e-mails, drafting motions, legal research, attending hearings – not to mention important tasks necessary to grow and improve the business, such as hiring and training new attorneys and tracking performance. It is our belief that these responsibilities are a more important way for the busy legal professional to spend his or her time.
Gulla CPA offers a full range of business bookkeeping, accounting, tax, and consulting services to our clients. Our team of CPA’s are always available for a free consultation to discuss your individual needs.