A law firm is a business and obviously needs financial reports to understand their financial health. But law firms have some unique requirements, resulting in some reports that are unique.
Like all businesses, law firms need a Profit and Loss Statement, a Balance Sheet, an Aged AR report and an Aged Payable report. These reports are the minimum for any firm to know how they are doing and have a sense of cash needs. Budgets, forecasting and cash flow reports are also needed for most firms.
Firms may additionally break out these reports for more detail. For example, the firm may want to run the Profit and Loss by practice area or responsible attorney for a greater understanding of the business.
However, there are three unique reports that law firms also need.
Most law firms have one or more IOLTA accounts, although they may use a different name like IOTA or Trust. The IOLTA account is not the firm’s money, and the Bar Association requires careful tracking of this money. In addition, co-mingling of funds is not permissible, including the firm's money being mixed with client money and also any individual client’s money being mixed with or used for another client.
To demonstrate accurate management of IOLTA accounts, firms should process a 3-way reconciliation each month to show that:
1. The balances by client (ledgers) equals
2. the adjusted bank balance and
3. the firm book balance.
While you need to pull information from three places to create this report, we consider it a single report. The report needs to be performed separately for each IOLTA account held by the firm.
Management of the IOLTA account is critical. It is the responsibility of the attorney and this responsibility cannot be delegated. Problems in the IOLTA account can lead to penalties for the lawyer including disbarment. At a minimum, questions around IOLTA accounts can lead to a lot of time spent providing explanations and resolutions.
Advanced Costs by Client
The second report that a law firm needs is Advanced Costs by Client. The IRS position is generally that Advanced Costs are actually loans to the client and therefore should be carried on the balance sheet, not on the Profit and Loss statement.
Certain types of practices may be able to put the expenses directly on the Profit and Loss Statement, but as a general rule, the balance sheet is better. Given this, the firm must know how much is outstanding in advanced costs for each client. When a case settles or a file is closed and there are outstanding costs, those costs either need to be reimbursed to the firm or written off. This can only be done if there is accurate tracking and reporting available.
Time-Based Reports: Work-in-Process (WIP), Non-Billable Time, and Time Billed/Collected
The third report needed by law firms is really a set of time-based reports - Work-in-Process (WIP), Non-Billable Time and Time Billed/Collected.
Most law firms bill by the hour. This means you need to know how much time is waiting to be billed. It becomes harder to collect payment when you wait longer to bill the client. Unless a case cannot be billed until completion, it is important to make sure that billing is done on a timely basis.
Even if a firm is billing flat fees, WIP is important for understanding the profitability of the flat fees and may be needed in event of questions by the client or the court.
Non-Billable time includes administrative time and time that cannot be billed to the client for any reason. The decision on non-billable could be done by the person entering the time or it could happen at the time the bill is reviewed and sent.
Time Billed/Collected reflects the difference between the time billed and the amount collected from the client. This reflects adjustments made after billing based on client discussion or non-payment. If a firm is compensating members of the firm based on collections, this is especially important. Regardless, if the firm is not collecting a high percentage of the time invested, the members of the firm have to work more hours to bring in the same level of revenue. Administrative non-billable time may also be important in compensation since it may reflect time spent on marketing and bringing in new business which is vital to the long-term health of the firm.
Value of Unique Accounting Reports for Law Firms
Law firms need unique information to make good decisions regarding growth and direction. What practice areas bring in the most profit, which attorneys are bringing in the most revenue, and other key questions can only be answered with good reports. Making sure the systems you use can provide the reports you need is important. Equally important is making sure you understand the reports. These three accounting reports will allow you to assist your law firm clients make good decisions.