Accounting for Law Firms
Just about any industry you could think of needs an accountant to handle the numbers and financial aspects of running a business, and law firms are no exception.
When it comes to accounting for law firms, like any field, there are a few things that set it apart.
Here is everything you need to know about accounting for law firms:
How Does Accounting Work for Law Firms?
Cash accounting is a process that reflects only the money that has been collected, while neglecting billings and works in progress. Accrual methods, on the other hand, reflect income regardless of whether or not the funds have been collected as of yet or not.
Nearly all smaller law firms will use cash accounting to keep track of their cash flow, monitoring income as it comes in and goes out of their hands. However, some larger law firms will use the accrual method instead.
Income Statements
Income statements are also often called profit and loss statements, or P&L statements. These reveal how well a firm performed financially over a specific time period. These are done in order to show the revenue that the firms have billed, the expenses they have incurred, and the resulting profit, or net income.
These profit or income figures, in general, have little relevance in a smaller law firm. These entities tend to operate using a cash basis, with the salary of lawyers being extracted from a positive cash flow. In these cases, analyzing profitability is simple. It usually only involves identifying and deducting the firm’s expenses from the cash received in a given month. The fixed expenses a firm would deduct typically involves the following:
- Staff, including taxes and salaries
- Rent, utilities, taxes
- Equipment, factoring in depreciation
- Outside services
- Malpractice insurance
The costliest expense on this list is the salary of the lawyer, which is why this is typically only increased in conjunction with the firm’s performance.
What This Means
Using these parameters, this means any attorney is able to create a personal P&L statement. Doing so allows them to document their own financial performance as an individual. The calculation is simple: Billings – total compensation and direct and indirect expenses. The result should be net profit!
All of these things, though, depend on the revenue of the firm. In a small practice, this income can be extremely variable and unpredictable. As a result, it’s a good idea to estimate it by using the accounting measure called turnover ratio. This is as follows:
Accounts receivable balance / the billings results per days in that billing period (either annually or monthly)
The result of the turnover ratio should leave a lawyer with the amount of payment they can expect for billings in the x number of days after the time that the client receives their statement.
The average result nationally for this statistic according to one study came out to be somewhere between 120 and 150 days. This meant it can take a firm as long as five months to receive their funds. To prepare for this, a smaller firm should be prepared to have the funds ready to operate for a minimum of six months without bringing in any new income.
The Verdict
As you can see, much of what a law firm—big or small—does is dependent on the profits or net income that it is bringing in. In order to know these numbers, however, having an accountant for any law firm is essential. It can make a world of difference in any firm knowing how they are doing, and how they can improve to increase their chances of success in the field!