Accounting is a fundamental aspect of managing a law firm. In fact, 81% of corporate decision-makers claim that their lack of assistance and expertise in accounting and other related responsibilities causes their organization to suffer.

So, it is essential to understand the basic principles of accounting to keep track of your finances accurately. Moreover, a solid knowledge of accounting principles can help you make better financial decisions. Eventually, you can achieve your business goals.

In this blog post, we’ll cover the essential steps to get your law firm’s accounting system up and running.

Create a Business Bank Account

To start with, you need to have a business bank account. Here are the steps:

Select a financial institution

Picking the right bank for your law firm depends on your specific needs and preferences. So, when choosing a bank, consider certain factors such as:

• compatibility with your POS (Point of Sale) system
• support for IOLTA (Interest on Lawyer Trust Accounts)
• security and fraud protection
• multiple user options for online banking
• fees and additional charges
• business savings accounts and credit cards

Open three accounts

After you’ve chosen a financial institution, open three accounts:

1. business checking account
2. savings account
3. IOLTA account

Firstly, manage your income in your checking account. And secondly, set aside funds in your savings account for future expenses. To open an account, you must have the following:

• a registered business name
• a state registration
• an EIN (Employer Identification Number)

Consider a business credit card

Credit cards should not be used as the primary source of funding for your law firm. But they can be beneficial when used strategically. A business credit card can help:

• improve your firm’s credit rating
• earn you rewards
• provide fraud protection
• keep you organized

Be aware of trust account rules

Besides business accounts, IOLTA is a separate trust account where law firms must hold client funds. Given the strict rules on their usage, breaking these rules can lead to severe penalties, even disbarment.

Each state has its own IOLTA program. So, it’s best to consult with the State Bar Association and a professional accountant before you set up your law firm accounting. Here are some common mistakes law firms make:

• borrowing from an IOLTA
• not keeping business and trust accounts separate
• misapplying fees
• recording trust deposits as income
• not keeping accurate records

Select an accounting method

When it comes to accounting methods, law firms can choose between the following:

1. cash accounting
2. accrual accounting

Your chosen method will have an impact on cash flow, tax filing, and bookkeeping practices. So first, you should consult with a CPA (Certified Public Accountant). Then, you should decide on an accounting method.

Cash accounting

Cash accounting recognizes revenues and expenses when cash is received or paid, respectively. Here are some features of this method:

• Cash accounting is simpler than accrual accounting.
• It can easily track cash flow.
• Income is only taxed once it’s in the bank.
• Accounts receivable or accounts payable aren’t recognized.

As a result, many law firms prefer this method.

Accrual accounting

On the other hand, accrual accounting records revenues and expenses when they are earned or incurred, regardless of when payment is received or made. Here are some features of this method:

• Accrual accounting gives a more realistic picture of income and expenses during a period
• This method can be misleading when it comes to cash flow unless proper monitoring is undertaken by way of cash flow statements reflecting actual cash flow from your operating activities.

Ultimately, the choice of accounting method will depend on the needs of your law firm. So, there’s no one-size-fits-all method.

Make a bookkeeping system

A suitable bookkeeping system ensures long-term financial success. The process involves:

• data entry regarding daily transactions
• bank reconciliations
• generating financial reports
• completing payroll

You have several options to manage your books, such as:

• doing it yourself using spreadsheets or accounting software
• outsourcing to a professional accounting firm or
• hiring an in-house bookkeeper

To choose the best bookkeeping method for your law firm, you should consider the following factors:

• the volume of bookkeeping required
• pricing
• time available
• confidence in handling the books

Remember, delaying bookkeeping tasks can lead to a more stressful and time-consuming approach at the end of the year-end.

Determine the method of receiving payment

The payment rules can vary from state to state. But most state Bar Associations allow electronic payment processing for law firms. First, you should decide which types of payments your firm will accept. Then, you will need to choose a payment provider to work with.

However, some standard processors will keep a percentage of each transaction as a fee. As a result, trust accounting laws can break. So, you need to be careful when you choose a merchant processor for your law firm. Certain legal-friendly services offer direct charging to the operating account to avoid such issues. Furthermore, automated invoicing solutions allow you to set up recurring invoices and record expenses. As a result, you save time and money.

Know about your tax obligations

Starting a business can complicate the tax payment process. For example, a legal practice may need to pay a variety of taxes at different levels of government. They can be based on factors like:

• location
• legal structure
• services

One key tax obligation is the income tax. The legal structure of your law firm determines this tax. For example, a Limited Liability Partnership will be taxed like any other partnership. And it must file Form 1065 and Schedule K-1.

Moreover, businesses with employees also have to pay employment taxes like:

• FICA (Federal Insurance Contributions Act)
• FUTA (Federal Unemployment Tax Act)
• state or municipal payroll taxes

Furthermore, self-employed individuals must pay federal self-employment tax. Plus, other tax obligations may apply.

Wrapping up

Accounting is crucial for a law firm’s success. Firstly, creating a business bank account and selecting an accounting method is essential. Additionally, establishing a bookkeeping system and payment methods is important. Furthermore, being aware of tax obligations is crucial.

To sum up, setting up an efficient and accurate accounting system is a worthwhile investment for long-term success.

If you have questions about accounting, you can seek guidance from GJM & Co. Our experienced professionals will help you understand the important details. Furthermore, we will suggest best practices and manage your financial accounts for you.

Should you have any queries or need consultation, Schedule a Call today or write to us at info@gjmco.in.