Why Law Firms Need Law Firm Accounting Software
All businesses need accounting software to help keep up with the money coming in and out of the business. Although law firms are a business, they have very specific needs that make their accounting needs significantly different. Two of the major differences include the accounting method relied upon by most law firms and the need to set-up at least one trust account. Because the law firm accounting process is special, the law firm accounting software must also be special. In this article, we’re going to explore these two primary needs that must be fulfilled in law firm accounting software.
Cash Accounting Versus Accrual Accounting
Starting with an Accounting 101:
In accounting, there are two primary accounting “methods.” These methods describe how the business realizes money in and money out. By “realize,” we mean—when does something actually hit the books? Do you realize revenue (for instance) when you send the invoice, or when the cash comes in the door?
Accrual Accounting. In Accrual accounting, which is used by most business types, you realize, or accrue revenue and expenses when service are rendered. Revenue, for instance: If you bill a client $1000, you realize (accrue) the revenue that day… Revenue goes up by $1000, and so does Accounts Receivable. The Accounts Receivable of $1000 is an asset, and (theoretically) the same as cash. The same is true for expenses—you realize, or accrue the expense as soon as an invoice comes in. When your monthly bill for rent comes in the mail, you accrue it in Accounts Payable (a liability), and it “hits the books” then and there, regardless of when you actually pay it.
Cash Accounting. Cash accounting is different. In cash accounting, you accrue revenue and expenses when you actually receive or pay it. Cash accounting is tied to actual cash in and out of the business (hence the name). If you invoice a client for $1000, its just vapor (doesn’t show in your books) until the actual money comes in the door. The same is true for expenses—you don’t realize the expense until the cash actually leaves your bank account.
Which method you use can have a dramatic effect on your business’ P&L statement, and therefor on the owner’s taxes. Most businesses, as I said, use the Accrual method of accounting, because money owed is the same as money spent, and money invoiced and owed to your firm is (in the world of accounting) the same as cash in the bank, a current asset like any other.
Law firms, on the other hand, usually use the cash method of accounting. On reason why is because it’s easier to manage. When the money is paid in, it is immediately marked as revenue. This makes tracking cash flow much easier. With accrual accounting, a law firm may not seem to have enough cash on hand to continue to operate and pay its employees. Accrual accounting also takes more time since everything coming in must be held and separated out as unearned.
And, yes, accrual accounting is very similar to managing an IOLTA trust account. Which, by the way, is our next point of discussion.
IOLTA Trust Accounting
IOLTA trust accounting is the process of taking retainers paid by your clients and placing them into a separate bank account. In many jurisdictions, the money must be placed in an interest-bearing account. The money held in trust for your clients may not be commingled with operating expenses. In fact, you can’t actually pay yourself out of the retainer money until that money is earned (services have been rendered).
It is an ethical requirement for lawyers to use a trust account to protect the money of their clients. Now, whether a law firm needs just one IOLTA trust account as a place to deposit all money paid by clients or they need one account for each client depends on your local jurisdiction. It’s very important that you consult the rules where you’re admitted to practice to understand your ethical obligation.
This money must be managed and accounted for in specific ways. Because of this, it’s imperative that law firm accounting software provides the tools you need to manage the money and to create the proper reports. While there are a lot of accounting programs to choose from, not all of them are designed specifically for law firm use. Some of the more popular accounting programs also say that they offer trust accounting, including Quicken and QuickBooks. The problem is that most bar associations don’t particularly approve of them since they may not truly guide you in the proper direction or provide you with the appropriate enforcement of trust accounting rules.
It’s very important that you consider choosing and implementing law firm accounting software that is actually designed for law firms and their needs.
Using Law Firm Accounting Software
When it comes to law firm accounting software, in general you can obtain it in two formats:
- As stand-alone, dedicated legal accounting software, or:
- As part of your Practice Management software.
Examples of stand-alone legal accounting software include Juris (by LexisNexis). Examples of legal accounting software built-into Legal Practice Management software include Tabs3, CosmoLex (by Tabs3), ProLaw (by Elite) and PCLaw (by LexisNexis).
Related: Juris in the Cloud
So, when evaluating law firm accounting software, first decide: Do you want (or need) separate legal accounting software, or would you prefer everything in one system?
If you choose a stand-alone law firm accounting software, you should make sure that it is made for the legal industry. This is one of the best ways that you can ensure that you have the IOLTA trust accounting tools you need. If you’re using a practice management software, you’ll also want to make sure that it integrates with your accounting software. Otherwise, you’ll run the risk of accounting errors if you have to manually move information from one program to another.