Accounting for Lawyers and Law Firms

Trust accounting comes first

Client funds held in trust must be kept separate from the firm's operating money, tracked per client and reconciled regularly. State bar rules set the requirements.

Retainers, settlement funds and advance payments for costs generally go into a client trust account, often called an IOLTA or a separate interest-bearing trust account depending on the amount and the state. You may move money to the operating account only when it has been earned or the client has authorized it.

Common requirements include a ledger for each client, regular three-way reconciliation, and records kept for a set number of years. Mixing funds, even briefly, is a serious ethics risk. Check your state bar rules and ask a professional familiar with legal accounting. Our broader bank reconciliation guide covers the process.

Set up the operating books

Use a chart of accounts built for professional services: fee income by practice area, payroll, rent, insurance, technology, marketing and client cost advances.

Keep operating income and expenses clean and in categories you can read at a glance:

• Fee income by practice area or attorney
• Reimbursable client costs, tracked separately
• Payroll and contractor costs
• Rent, technology and legal research subscriptions
• Malpractice and other insurance
• Bar dues, continuing education and marketing

Decide between cash and accrual accounting with your accountant. See cash vs. accrual accounting. Most small firms use cash basis for taxes but track work in progress for management. Also review how to start a law firm and the costs of starting a law firm.

Billing, collections and write-offs

Bill on a predictable schedule, require retainers where appropriate, and track unpaid fees. Slow collections are a leading cause of cash shortages in firms.

Law firms often finish the work before they are paid. Without a firm billing routine, receivables grow. Practical steps:

1. Use written engagement agreements that spell out rates, retainers and payment terms.
2. Bill monthly or on milestones, not at the end of the matter.
3. Track aging of unpaid invoices and follow up quickly.
4. Decide in advance when to write off a balance.
5. Keep time records current, since late entries get lost.

See tips for collecting unpaid invoices and sending invoices that get paid faster.

Watch cash flow, not just revenue

Contingency and flat-fee practices have uneven income. A cash forecast and a reserve for payroll and rent are essential.

A strong month on paper does not guarantee cash. Contingency fees arrive when cases resolve, which may be months or years later. Hourly work depends on client payment speed. Meanwhile, rent and salaries are due every month.

Build a rolling 13-week cash forecast and keep a reserve equal to several months of fixed costs. Read cash flow forecasting and cash flow vs. profit. Pay owners on a steady schedule, and put aside money for taxes. Our owner pay guide explains common approaches for single-owner entities.

Reports to review every month

Review a profit and loss statement, balance sheet, receivables aging and trust account reconciliation each month.

A monthly review rhythm keeps surprises small:

• Profit and loss compared to the prior month and budget
• Balance sheet showing cash, receivables and obligations
• Aging report of unpaid client invoices
• Trust account reconciliation and unresolved items
• Cash forecast for the next quarter

For definitions, see income statement vs. balance sheet and necessary reports for small business accounting. A bookkeeper who understands legal practice can save time. See also funding for law firms.

When a firm needs outside funding

Firms borrow for office build-outs, technology, hiring associates or bridging slow-paying matters. Fund only what the added revenue can repay.

Law firms are service businesses with limited hard assets, so funding usually rests on cash flow and bank deposits. ROI Funder places working capital, a business line of credit and term loans for firms with 500+ FICO, 6+ months in operation and $20,000+ monthly revenue.

Do the math first. In this illustrative example, hiring an associate costs $9,000 a month all in and is expected to bill $18,000 a month after a three-month ramp, so you must fund roughly three months of the ramp. Repayment should fit that plan. A complete file, the application plus 3 months of bank statements, can be funded the same business day when approved. Note that client trust funds must never be used for firm borrowing or collateral.