This summer, we’ll be focusing on the tools you need to know when it comes to determining your firm’s profitability. As a practice owner or managing partner, it’s easy to get into a routine for handling your business processes. These tools can help you evaluate whether your routines and SOPs are boosting your profitability or just becoming a rut.
The number one thing to be aware of, especially when talking to other small business owners who are not attorneys, is that the accounting requirements of law firms are unique. Between different billing styles, advanced client costs, retainers, and appropriately tracking and allocating earned funds, the financial reports of other businesses or examples you find online simply don’t cover these areas. Because these templates miss crucial parts of legal accounting, they will not suit your needs and could lead to some costly bookkeeping mistakes.
The first tool in our summer series is your Chart of Accounts. Before diving into your specific reports, it’s important to understand what goes into them. Let’s start by evaluating what types of accounts you have and correctly designate them by function when setting up your Chart of Accounts. In addition to your standard operating and expense accounts, your Chart of Accounts will contain General Ledger accounts that are specific to a law firm’s business:
- Client Trust Accounts/IOLTA Funds – These accounts are arguably the most important distinction law firms have from other types of businesses. These are classified as a liability. Simply put, these funds still belong to the client until you earn the fund and appropriately bill the account. The mishandling of these accounts is the number one cause of disbarment in the United States.
- Reimbursed Client Expenses- These accounts represent the funds that have already come in as a result of reimbursement for a cost incurred as a direct result of a client’s matter.
- Fee income
- Reimbursable client expenses (cost of goods sold)
- Unrecovered client expenses (expenses absorbed by firm)(expense)
These accounts fall into 5 categories and into 2 different types of reports that we’ll discuss more in-depth as we evaluate the tools at your disposal.
- Assets- What your business owns
- Liabilities- What your business owes
- Equity- The difference between Assets and Liabilities
- Income- Gross Revenue
- Expenses- Costs for activities
Your Income and Expenses are evaluated on your Profit and Loss Statement while your Assets, Liabilities, and Equity appear on your Balance Sheet. Together these two reports will create your Cash Flow Statement.
Your Chart of Accounts gives you the building blocks you need to generate accurate reports for understanding your firm’s profitability. It’s easy to see how misrepresenting one of these unique accounts can have a domino effect on your firm’s accounting.
As you begin building your healthy financial review process, get together with your bookkeeper to review your Chart of Accounts. This is especially important if your books aren’t making sense. Confusion can often be caused by how your general ledger accounts have been categorized. Your bookkeeper can help you understand why Client Trust/IOLTA Funds are a liability and not to be treated as income. Once you’ve gotten your Chart of Accounts straightened out, run your reports again and you’ll likely find them much easier to understand now.
Don’t forget, you don’t have to navigate your books alone. CPN Legal has great resources to help you build your reports and to understand them. In understanding your data, you have a better idea of what steps to take next to help your business grow and thrive.