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Every month, firm administrators, attorneys, and billing professionals sit down to handle one of the most dreaded law firm responsibilities: legal billing. It’s not that they don’t appreciate the value of invoicing; they just hate how tedious it is!
From managing the entire process to tracking down time records from timekeepers, legal billing tasks can hamper a law firm’s potential for billable hours and profitability if not handled in an efficient manner.
The following are some tips for bringing a law firm closer to a more structured and simplified legal billing process:
To streamline their legal billing procedures, law firms should start with a simplified time tracking process. The entire billing process begins with documenting tasks completed for clients. When these records are inaccurate or inadequate, it makes invoicing more difficult to complete. Firm staff members must then spend time chasing time tracking records, throwing off the entire process.
A structured billing process starts the moment a timekeeper completes a billable task. A comprehensive legal time tracking system makes this happen in a variety of ways. This allows timekeepers to track time at any point using whatever method they prefer. For example, when working in the office, an attorney may want to record time as they save documents in Word or send emails in Outlook. With a complete time tracking platform, time can be entered within applications your firm is already using - like Word and Outlook.
Mobile application time tracking helps enter time with speed and accuracy. With this tool, timekeepers can conveniently log time on a mobile phone or other portable devices when completing tasks away from the office. This type of legal billing tool has become invaluable in an environment where attorneys are increasingly working remotely.
To simplify the billing process, firms should move their invoicing procedures to a paperless process. Electronic billing (e-billing) software is the most effective way of simplifying the billing process, making creating, presenting, and collecting client invoices more efficient. Not only do these options financially benefit your firm, but they also improve client relations by minimizing errors and inconsistencies.
For a legal practice, the time between the completion of a task and the collection of a client payment is crucial. Payment time directly affects a law firm’s cash flow, which is necessary for handling office overhead costs. Inadequate cash flow is a common problem for law firms, so it is important to track this metric and work to shorten the time frame.
Firms need simplified billing systems in place that help transform payment times from months into weeks. E-billing is an effective tool for getting this done. It helps address bottlenecks that slow down the process by offering the following features:
Clients are more inclined to make quicker payments when provided with more channels to do so. The majority of modern households utilize online payment methods to conduct business. Consumers want and expect convenience when choosing where to spend their dollars, and that extends to legal services. By offering a variety of convenient payment methods, law firms incentivize their clients to pay invoices in a more timely and complete manner.
Historically, attorneys have been hesitant about the acceptance of credit card payments. They view paper checks and cash as adequate payment methods for services rendered simply because those methods have always been utilized. But this “good enough” mentality can work against law firms by making the payment process more challenging to navigate for clients.
Implementing a credit card payment processing system is critical to simplify legal billing and here are a couple of reasons why:
To maximize the acceptance of credit card payments, law firms also need to offer an integrated option for clients to make payments right from their computer or smartphone. Clients appreciate convenience and ease, so firms need tools like client portals that facilitate these quick payments.
Law firms can simplify their legal billing process, and even expand their client base, by implementing the acceptance of credit card payments. But remember, credit card payments are just a portion of this simplification. E-billing and simple time tracking combined with multiple payment options are sure to make your billing easier for internal and external clients alike.
The billing department is the lifeline of a law firm, ensuring that the practice effectively bills and collects compensation for services rendered. Its reach extends from the time tracking phase to reporting on key financial metrics. If the billing department proves unsuccessful at fulfilling its duties, the entire firm may suffer fiscal losses, including inadequate cash flow and an inability to manage overhead costs.
Law firm billing departments typically have two major goals in mind. One is to streamline the invoicing process, so that timekeeping administrators can spend more hours on billable client tasks. The other is maximizing billing accuracy to promote timely payments and reduce client disputes.
Unfortunately, three common challenges may get in the way of these goals:
Practice management software can play a significant role in helping law firm billing departments overcome their challenges and meet firm goals. Keep reading to learn how.
Many law firm billing departments rely solely on a limited number of people to manage the entire invoicing process - from time tracking to invoicing and payment collections. If that handful of people becomes overwhelmed or unable to fulfill essential tasks, the entire invoicing process can suffer, creating a financial risk for the firm. This type of narrow setup is also vulnerable to personnel changes. The separation of even one member of the billing department could mean that a vital piece of the billing machine grinds to a halt.
Law firms cannot afford to trust such an important, business-critical process to only a couple of employees without safeguards in place that standardize the processes so that they can be learned and applied by other members of the firm when necessary. Tools like automation and e-billing help law firms create a systematic process that can be understood by managing partners and administrators, as well as easily taught to new members of the billing team.
Practice management software provides law firm billing departments the level of flexibility they need to maximize even the most limited staffing capabilities. It provides mechanisms for simplifying processes, eliminating the need for multiple software services, and systematically managing department tasks. Once firms set their billing processes in place using practice management software, they can ensure that their billing processes will successfully proceed, no matter what changes or limitations may occur within the billing department.
Law firm billing departments take on a variety of responsibilities under the watchful eyes of firm managers, partners, and administrators. After all, every single firm member relies on the billing department to ensure that money earned translates into actual revenue (and payroll). With such high stakes, billing departments need streamlined processes that result in timely and complete collections.
Practice management software assists with this goal in a number of ways:
Another huge benefit of practice management software is the inclusion of trust accounting resources. Trust accounting is one of the most important law firm billing department duties. Inadequate practices can place firms at risk of potential ethical violations, but the right tools help billing teams handle trust accounting accurately and in compliance with jurisdictional requirements.
Legal practice management platforms offer all of these billing and accounting solutions in cloud-based software, which provides a level of remote accessibility that has become absolutely essential within today’s law firm environment. When unexpected business interruptions occur, law firm billing departments need the ability to continue invoicing and collecting payments. Cloud-based practice management makes that happen.
Law firm administrators and partners want detailed billing data that helps them keep a pulse on the fiscal health of the firm. Without this information, they cannot make informed decisions about the firm’s direction. Legal practice management software helps billing departments generate the reports that the partners need.
It only takes a few clicks to generate data-specific matters, practice areas, or the general ledger. Year-over-year reporting provides detailed comparisons between current and past years, while month-over-month reporting offers shorter timeframe reviews.
Practice management software allows law firm billing departments to customize their reporting and generate data sets relating to:
With comprehensive reporting, partners and law firm administrators can gain deep insights into a variety of additional firm details, including average hourly rates, budget compliance, law firm efficiency, and more. The modern e-billing solutions of practice management software give billing departments the ability to extract rich data from invoices and generate detailed reports that would otherwise take an inefficiently unreasonable amount of time.
The expansive responsibilities placed on law firm billing departments necessitate a system that streamlines processes and promotes maximum efficiency. Legal practice management software provides the features that improve processes and drive law firm revenues.
There is a lot involved in the financial management of a law firm. Fortunately, with a good understanding of the principles of law firm finances, firms can reap the benefits of a quality time & billing and financial software system that allows them to handle their firm’s management with ease.
Let’s dive in.
It is common knowledge that improper handling of trust accounts results in the highest cause of bar issues for attorneys. It is imperative that the firm’s trust account be handled by a manager who knows what they are doing and that the managing partner maintains close oversight as well.
Your firm’s legal software should have the ability to track each client’s trust fund balances. By having your time & billing software and your financial software all on one platform, you can maintain accurate records without the need for double entry into two systems. Each month, the firm’s manager should reconcile the firm’s trust account with the bank statement, and following that reconciliation, he or she should run a report showing the trust account balances for each client. The total from the client trust listing report should match the total for the firm’s reconciled bank balance. These reports should then be provided to the managing partner for full transparency.
A common mistake that leads to bar complaints is when a firm transfers funds to the operating account before the client has been billed. Trust funds should remain in the trust account until the client’s regular billing cycle. When funds are transferred to pay an invoice, it is important that the invoice template is clear as to what has been billed and transferred from the client’s funds, and that invoice should be provided to the client so that they have a clear understanding of their trust account’s status.
The firm should not keep more than a small amount of the firm’s funds in the trust account. The sole purpose of keeping firm money in the account is to cover any potential wire fees that may result from an automated clearing house (ACH) coming into the account.
Another common mistake that firms make is transferring funds from the trust account before they have cleared. Gone are the days when a certified check can be treated as cash. Standard protocol is to wait 7-10 days for a deposit to truly clear before drawing on those funds. If the funds are drawn before they are confirmed to be “good,” the firm is essentially using another client’s funds.
It is important that law firms use Engagement Letters (EL) to spell out the agreement between the firm and the client. The EL should define the scope of work, the agreed rates the client will pay for the work, how often the client will be billed, and any interest fees the firm charges for late payments. It should be signed by a partner and countersigned by the client.
Non-representation letters are often overlooked by firms. If a firm discontinues work for a client, or if they provide a consultation to a potential client but do not engage in the work discussed, it is important to send a non-representation letter so that there can be no claim made that the firm was responsible for handling the matter.
Like any business, law firms have a cost of doing business. Do you know what it costs your firm to have an attorney working on a case? You may think it is just a matter of their direct compensation, but there is more to it than that. By using cost accounting methods, you can combine your attorney’s direct compensation and their share of the firm’s overhead and divide it by the number of hours they typically bill annually to know what their break-even rate is. By calculating this rate, you know what you need the attorney’s billable rate to be in order to receive any profit from that attorney’s time. Taking the time to perform this exercise is very valuable to your firm.
Accepting credit card payments from your clients can result in faster payment, improving your law firm's cash flow. It can also result in receiving payments that you may not otherwise receive if you have clients with cash flow issues. It is important to use a credit card processing service that will allow for the separate distribution of your fees to your operating account, in addition to your retainers and settlement payments to your trust account. Law Pay is an example of a service that can assist with legal settlement accounting.
Many businesses charge their customers a fee for using credit cards. It is important for law firms to understand that the ability to follow this practice varies from state to state. You need to consult your state bar to determine whether it is considered ethical in your state to pass on those fees to your clients. You will also want to consider, even if you are allowed to pass on those fees, whether it is good business practice for your firm to do so. Will passing on those fees leave a bitter taste in the mouths of your clients? Are you better off increasing your rates by $5 an hour to cover the cost of accepting credit cards?
Do you know what your billing and financial reports mean? The best way to have accurate reports that you can rely on and to avoid the issue of having to practice double entry recordkeeping between multiple software applications is to use one software that hosts both time & billing and financial data in one platform. For example, by having everything in one place you should be able to accurately and efficiently run reports that show you things like effective billing rates so that you know if after write-downs and write-offs your attorneys are billing at a rate that is higher than their break-even rate so that your firm will see a profit.
Law firms today are finding it increasingly necessary to meet specific client needs with their invoices. If your firm is to receive payments from clients in a timely manner, it is important that your invoices communicate the information expected by each client in the format that they require. With the right software and planning on the front end, this does not have to be an onerous task.
To begin, there are some criteria that should be included on every invoice, regardless of the invoice format or template. You want to ensure your invoices provide:
Research shows that time not kept concurrently results in as much as 30% of billable time lost. By using a system that provides a timer and ease of use for time entry, attorneys can easily track their own time in the billing system as they are working, ensuring both efficiency and accuracy of your billed time. With user-friendly software, it is no longer necessary for attorneys to handwrite their time entries, with a staff person paid to take the time to enter those tasks into your billing system.
Not to mention, attorneys can utilize technology that will allow them to automatically capture time throughout their day without missing a beat. Whether they're texting a client about an upcoming meeting, sending documents over email, or answering a call after hours, every second is automatically captured and converted into a time entry.
By using software that allows the use of multiple billing templates, your firm can create templates to meet each individual client’s needs. While some clients will pay your invoices regardless of the format (as long as the information is communicated clearly), if you have corporate clients or represent insurance companies, you will find you have many that have specific requirements. By assigning the appropriate billing template to each matter on setup, you can ensure that each client is automatically receiving their invoice in the format they require.
Additionally, make it easy for your clients to pay you directly from their bill. Think about all the bills your clients pay on a monthly basis... from utilities to internet and wifi, cellphone, the list goes on and on. And then when you think about how people are paying these bills, you'll come to find that a majority of them are being processed online electronically. So meet your clients where they already are and offer credit card payments of eChecks. Some of your clients may prefer snail mail and that's okay, but the world is trending digitally, so it is becoming best practice to offer both payment methods.
Do you have clients who have billing requests beyond the formatting of their invoices? For example, if you typically email invoices but you have some clients who require their invoice to be mailed, how does your billing staff remember this each month? By setting up pre-bill notes in your matters and using a pre-bill template that will show those notes, when your billing staff is ready to run the final invoice, they will have that information directly in front of them.
Other information that may be included in pre-bill notes is whether there is a special agreement for the matter – is it a flat fee, a contingency matter, or does it have a fee cap? How about a budget? By including all of this information in a way that it will show on the pre-bill, you will save your staff time (and therefore the firm money) while also ensuring that special agreements with clients are not missed.
You can meet your client needs while also working smarter, not harder, by having specific templates assigned to each matter and tracking time in the billing system concurrently. Invoices can then be generated efficiently and painlessly at the end of each billing cycle, improving your law firm's cash flow and resulting in prompt payment from happy clients.
Law firms who wish to work for insurance carriers or larger companies are finding it almost impossible to do so if they are unable or unwilling to practice LEDES e-billing. For the firm manager who has never dealt with LEDES e-billing requirements, the task can feel daunting. With a basic understanding and a few tips to get your invoices approved through the audit process, your firm can accept clients who require e-billing without fear.
LEDES stands for Legal Electronic Data Exchange Standard. This billing format was created in 1998 to address e-billing issues. It creates uniformity among all law firms to assist corporations and insurance companies in processing and comparing law firm invoices.
The LEDES process requires firms to use a defined set of Uniform Task Codes (UTBMS). There are different sets of UTBMS codes used for different matter types. The most common set used is the Litigation Set, but there are also sets for Workers Compensation, Counseling, Projects, and Bankruptcy, for example. Full detail of the code sets can be found on the American Bar Association website.
For starters, you need to ensure that the task codes used for each billing entry come from the UTBMS code set for the practice area in which you are billing (typically the litigation set). Some firms require their timekeepers to enter the codes as they enter their time entries; other firms allow their timekeepers to enter a normal billing entry, and the billing department will edit each entry at the time of billing review to include an appropriate task code.
Your invoices will need to be created in a LEDES format which will allow the invoice to be uploaded into the e-billing system that your client is using and be read on the receiving end. These invoices are uploaded to a third-party administrator’s site. There are several third-party administrators (TPAs) out there, and you may find that you have different clients using different TPAs. Your invoice will first be audited by the TPA, and they will review your entries for acceptability before releasing them to your client.
It is important to understand that the TPA is going to analyze every entry, looking for entries they can reject as unacceptable. You want to start by reviewing your client’s billing guidelines very carefully to have a full understanding of what their billing requirements are, what they will pay for, and what they will not pay for. Many clients who bill under this format are unwilling to pay for some firm expenses. For example, items like postage, photocopies, and online research may be considered by the client to be operating expenses that they will not reimburse.
The firm administrator or billing supervisor should review your LEDES pre-bills very carefully prior to submitting your invoice so that you can avoid rejections. Items to bear in mind include:
You will receive an email from the TPA indicating whether your invoice has been accepted. This does not mean that it has been approved at this stage, it just means it has passed the first hurdle. There are several items that could cause your invoice to be rejected at this stage:
Once your invoice has been accepted, it will be reviewed by the TPA. Each entry is analyzed. Any entries that show block billing, clerical work, or attorneys performing paralegal tasks will be rejected. You will need to watch for your invoice to either be approved or have entries that have been rejected. If entries are rejected, you have the opportunity to appeal that decision. You need to follow the protocol for the TPA’s system to appeal or accept the rejections. If they are claiming something is clerical in nature, you may be able to appeal the decision and provide more detail to show why it is not clerical. You may decide they are correct in their rejection and accept the rejection of that entry.
Once the process has been completed and you have final decisions, you will want to write down the invoice balance due in your billing system to reflect any rejections that you have accepted.
Your time and billing system should be set up with the UTBMS codes already in place. It should also have templates available for you that create your invoices in the required LEDES format automatically.
While LEDES e-billing can feel overwhelming at first, with some understanding of the process and the right time and billing software in place, you can accept clients with confidence that you can successfully meet their billing requirements.
The legal billing process can be a challenge for every law firm, but it doesn’t have to be. A combination of the right policies, procedures, and technology can be used to stay on top of attorney time and make the billing process efficient and accurate.
Software that encompasses both practice management and time and billing in one platform is an effective way to keep everyone on the same page and meet your clients’ needs. Use your firm’s legal software and good policies and procedures to:
Your law firm’s billing protocol should start with your client onboarding process. Using your practice management software, create a standardized client intake form that captures all of the necessary information upfront. It is important to set appropriate expectations from the start. Once the client and attorney have agreed on a budget and a billing rate, an engagement letter should be sent to the client for signature to ensure all parties have acknowledged in writing what is included in the representation and what the fees will be for that scope of work. Best practice steps include:
Once the client has been engaged and you have received the returned EL (and a retainer payment if one was requested), it is time to get to work. Your firm should have protocols in place that set clear expectations for your attorneys with regard to posting their time to your time and billing system promptly. Research shows that up to 30% of fees are lost when time is not captured concurrently. Best practice steps for a firm billing policy include:
Some clients require LEDES e-billing, and it is important that your time and billing software support this requirement. The American Bar Association has created a Uniform Task-Based Management System (UTBMS) that allows large clients (typically insurance companies, but sometimes large corporations), to track the work their law firms are performing by task. The Litigation Code Set is most often used, but there are other sets for Counseling, Project, and Bankruptcy Codes as well.
For your clients who use the LEDES e-billing practice, it is important that your time entries are drafted very carefully. Your invoices will be reviewed by a third-party administrator who is looking for anything that appears to have the potential of being an uncovered activity. Best practice steps for LEDES e-billing include:
When it comes time to send your clients their invoices, if your attorneys and paralegals have kept accurate, concurrent time and they have followed your firm protocols for time entries, the billing process should be painless. Your time and billing software should allow you to have a billing template that is specific to your firm. Some software will allow you to review invoices in the pre-bill state within the system, where partners can review the pre-bills, forward questions to timekeepers on their time entries, and release the pre-bills to be invoiced when questions have been answered. Best practice steps in the billing process include:
The monthly law firm billing process does not have to be painful. With the right technology and a few policies and procedures in place, your process can run smoothly and you can have accurate invoices that show value your clients are willing to pay for.
How are changes in today’s climate impacting your law firm profitability? Technology has changed our world significantly, and law firms are slowly catching up to the rest of the business world in many areas. Gone are the days of the large offices, where every attorney has their own secretary, and the firm houses a large library full of books that must be manually updated with those supplements that would arrive on a regular basis, much to our chagrin.
As we have slowly joined the rest of the world in the ways of online research and paperless offices, we are also considering more appropriate ways to look at profitability. This is due, in part, to client demand. Clients no longer accept the idea that they will pay our firms by billable hour, with no budget or foreshadowing of what their final out-of-pocket expense may become. Technology allows for broader communication and stiffer competition, and if we want to remain competitive, we must become more efficient and readily able to consider alternative fee arrangements (AFAs) such as flat fees, risk collar agreements, etc., or at the very least, offer accurate budgets that clients can count on so that they know their worst-case scenario.
While we may have given in to the fact that we must agree to these terms in order to get the work, many firms find themselves no longer profitable as a result. Where they are falling short is in the failure to recognize that, like other businesses, they must have a cost accounting model that allows them to understand what their cost is for producing the client’s product before they can agree to a sale price.
If you think only manufacturing companies can use cost accounting methods in their businesses, think again. Law firms who are using these methodologies will leave behind those who don’t educate themselves in these practices. You may not be producing widgets, but you are selling a “product” (time) that can be measured in order to determine the cost to produce that product. By implementing a cost accounting system, you will be able to determine profitability by producer, department, office, client, and matter. (You may be surprised to learn that your largest fee income client is not necessarily the largest contributor to your bottom line!)
So how does a firm determine the cost of their product? It isn’t as complicated as you may think. By determining the direct costs of your timekeepers (salary, payroll taxes, insurance, training, etc.) and allocating the remaining firm overhead to your timekeepers (how the overhead is allocated to differing timekeepers is another article in itself), you can determine an annual cost per timekeeper. By then looking at the number of hours each timekeeper bills per year, you can determine their hourly cost. (Timekeeper annual cost including overhead allocation ÷ number of hours billed = timekeeper cost per hour.)
Once you have determined the timekeeper’s cost per hour, you can readily understand what you can (and cannot) afford to offer as your billable rates and AFAs. You can determine the necessary billable rate for each timekeeper in order to meet your profitability goals, taking into account anticipated write-downs and write-offs (typically 10 percent). You will also know very quickly whether you can afford to offer a client a discount on any given invoice and still receive a profit on that work.
By doing a small amount of legwork on the front end to create a model that works for your firm, you can
One final note – be sure to require your attorneys to capture their hours, even on flat fees and other AFA arrangements. If you don’t, you will not be able to determine how successful your AFA models are working for you in helping you to maintain profitability.
What does your law firm's cash flow look like this year? How about your net income by year-end? Having a quality budget in place removes the guesswork and fear from your financial picture and ensures you end up where you want to go. We have all heard the phrase, “Failing to plan means planning to fail.” A good budget will not only help to forecast net income and cash flow, but it will help you to plan for potential problems before they become emergencies.
The two most common types of budgets are zero-based and incremental. If you are a new firm with little to no history, you will need to start with a zero-based budget. A zero-based budget is just what it sounds like – you start at zero and forecast each expense you anticipate incurring, as well as the revenue you hope to achieve.
With incremental budgeting, you have the luxury of looking back at your history and creating the next year’s budget based on what you have experienced before. Be careful though – with incremental budgeting, it can be easy to fall back on past numbers with little effort made to improve efficiencies and drill down on ways you can do better.
Regardless of the approach you take, the first step is to ensure you have a good general ledger chart of accounts. If you are not familiar with the chart of accounts, it is simply a list of income and expense categories used to track your spending. In a law firm, typically your income is fee income. You may also have a rental income if you own a building and rent a portion of it to other tenants. When it comes to expenses, you want to find the happy medium between having enough detail to aid you in future years without having so much detail that it is a cumbersome system to use. It is also helpful to ensure you keep any expenses pertaining to meals separate – your CPA will need to know that number at tax time because your meals are not 100% deductible!
Don’t plan in a vacuum. Start by reaching out to all stakeholders in your firm. What do their CLE expenses look like for the year? Any conferences planned? How is the equipment looking? Is anyone going to need any major purchases to replace outdated equipment? What about staffing? If leadership is planning to add more employees to the firm, you need to know whether you are going to have the money to cash flow that addition. Attorneys typically take six months before they show a profit for the firm.
It is helpful to use a spreadsheet for planning your budget. You should have a sheet for income, a sheet for expenses, and a sheet that links the bottom line of your total income and expenses so that you can see your forecast net income.
Begin your budget by estimating income. In your budget spreadsheet, you can estimate the fee income for each timekeeper in your firm. It is a simple list for each timekeeper, with their estimated billable hours for the year multiplied by their average realization rate. Your financial software may be able to run this realization report for you – if it does not, you can estimate a fairly accurate number by looking at the timekeeper’s previous history and dividing their fee receipts by their billable hours. If your firm has any contingency matters, don’t forget to account for them as well – some may be at a stage where there is guaranteed income to the firm, and some may still be truly contingencies – you should account for the contingencies in a separate line item that is not counted on.
When it comes to budgeting for your expenses, be sure you have a good plan for your GL accounts before you start. Try to anticipate everything you may want to be able to track in the future. Your financial software should allow you to have parent accounts and sub-accounts. For example, you may have a set budget for firm events for the year, but you may want to be able to track what the firm spends on the annual holiday party v. its summer outing and its annual Administrative Professionals’ Day celebration. You can have a parent account for firm events, with sub-accounts for each of those sub-items. This will allow you to easily plan in future years by having a quick picture of your historical spending.
Another great way to use sub-accounts is to track costs the firm incurs for each attorney. Examples include insurance, association dues, CLEs, conferences attended, etc. By creating a sub-account for each attorney, it is very easy to run a report from your financial system to track their direct costs when you want to determine their true profitability for the firm.
When you have completed your income and expense entries into your spreadsheet, ensure that you end up with the desired net income at the end. If you don’t, you need to sharpen your pencil!
When it comes to entering your budget into your financial system, be sure you are entering the expenses in the month that you expect them to occur. Some items will be spread equally throughout the year, like rent and equipment leases. Others will occur in specific months, like professional liability renewals and holiday parties. By planning for your professional liability renewal to occur in the appropriate month, you can have your eye on the ball in cash flow planning and avoid the extra expense of paying for financing your premium.
Use your budget for decision-making. If someone is requesting something that was not planned in the budget, is it necessary? Is it something that can wait until next year? If not, is there a way you can make up for the added expense by changing your spending in some other areas or increasing firm revenue?
Once you have entered your budget into your system, make sure you monitor it regularly. You should be running a monthly YTD income v. budget report to track how you are doing against your budget. Don’t despair if you see variances v. your budget. No budget is perfect, but by having one in place and monitoring it regularly, you can prevent any big surprises and make contingency planning when necessary.
When firms are asked, “How do you want to define growth,” the leading response is always through revenue. This response consistently outranks growing a larger client base, expanding staff or hiring more attorneys, and adding more practice areas or geographical locations.
However, not every firm is growing. Today, there are three groups of law firms in the industry that are actively working on open matters. Those are firms that are growing, firms that are stable, and firms that are shrinking. The biggest hurdle that solo, small, and even medium firms are facing is finding billable work. In a typical 8 hr workday, most law firms have trouble billing more than 2.5 hours of work per day (we call this utilization rate, this is important for later). And even then, once the actual bill goes out, firms are only collecting about 1.7 hours worth of billed time. So, not only are firms having a hard time finding and focusing on billable work, but they’re having a hard time collecting on the time they do bill.
A firm’s utilization rate is calculated by dividing the number of billable hours by the number of hours in your workday day. So for example, if you’re billing 4.3 hours of work in an 8-hour workday, your utilization rate is 54%. When we look at the utilization rates of each of the three types of firms, this is what we see: stable firm’s utilization rates stay very similar throughout the course of time. Growing firms are experiencing increased utilization rates, meaning they are finding more time they can bill for, while conversely shrinking firms face lower and lower percentages over the course of time. The takeaway here is there’s a paradox that is happening between law firms and growth, and it’s something the industry needs to figure out how to tackle.
Before we jump in, it is important to note that you’re not supposed to know everything we cover in this blog. If you do great! But if not, that is okay, you’re lawyers, not accountants. However, as a business owner or as someone heavily involved with the revenue projections and future evaluations, it is important that you have a foundational concept to improve your firm.
A third of an average attorneys day is spent doing what makes them money. So that means a whole ⅔ is spent on tasks that don’t bring in money, really think about that. The problem with this is that the industry has seemed to settle. These rates have become normal and standard and because of that, we have seen little change. But the real problem stems from the fact that we cannot manage what we do not measure.
Let’s go through some basic accounting terms that everyone should be familiar with:
Some common questions that come up include:
Financial statements are typically structured by columns and rows, with comparative periods, and the overarching reason we use them is to tell better stories. The accuracy to which you can tell your firm’s story relies solely on your record keeping. Your chart of accounts is a list of categories to record business transactions. The transactions recorded within these categories are listed in detail on your general ledger. Financial statements summarize those details entered in your general ledger. The basic elements of a chart of accounts is the account name, account number (if used), the account type, and balance. The right chart of accounts is so vital because it will provide a picture on your financial statements of your firm’s financial health.
Now that you have all this information, the next question you may be asking is why is this important to me and my firm? Why do we even need these things?
Of course, law firm’s are businesses, and financial statements provide the best way to manage a business. Oftentimes, we see firms who do not have heavy experience with accounting or finances turn a blind eye to the numbers because they simply do not know how to use them. And with accounting particularly, it is second nature for people to shift the ownership of the task versus jumping head first into doing it. If your firm’s number one priority is to grow revenue, how are you tracking that? Are you setting targets? How are you measuring your progress?
Your profit margin essentially illustrates (by percentage) how many cents on the dollar are being generated for your business. And this can be determined by dividing your net income (income after taxes) by your income.
If you have multiple practice areas within your firm, you may be tempted to blend your profit margins together. It is best practice to keep these margins separate between practice types to provide you with a better picture. Bad numbers have incredible power to give you bad advice. You could have one practice area that is considerably underperforming, but if you’re blending your margins, it would be unlikely that you would be able to see that. Without that information, you would have no idea where to best shift your resources to either continue bolstering your more profitable areas of practice, supplement the areas that are falling behind, or even eliminate an area that continues to be unprofitable.
This data on your balance sheet shows the assets, liabilities and owner’s equity at a specific point in time for your firm.
Types of assets include:
Liabilities include:
Lastly, equity is synonymous with net worth. It is the ownership interest in a business. It includes:
When all is said and done, your assets must equal your liabilities plus the ownership’s equity. If they don’t there is something wrong.
It is important to note that although equity and debt are ways to fund your business, both are vastly different in the way they affect your business’ financial health. When using equity, you are either giving away future earnings or purchasing future earnings of the business. When using debt, your business borrows from another party, with the condition that it is to be paid back, usually with interest, at a later date. When taking on debt, you are assuming that you will be able to pay it back within a certain period of time, but you are also taking on the risk of default.
By looking at the balance sheet, you can quickly identify your current cash on hand, as well as what your firm currently owes to its creditors.
On your balance sheet, your IOLTA cash is represented both as an asset (IOLTA bank account) and a liability (client retainer liability). These funds belong to your clients and should never touch your operating account or profit and loss statement until you actually earn that money. IOLTA accounts are heavily regulated and the misuse of these funds could potentially cause a multitude of problems for you and your firm, up to and including disbarment. Because of this, IOLTA accounts and the balancing client retainer liability accounts have a unique place on the balance sheet.
This is incredibly unique to law firms. So much so that it is advisable that when you are hiring an accountant or expanding the team who controls your bookkeeping, you ensure that they are very familiar with law firm accounting.
If you believe you may be running into issues with your trust accounting, review your current balance sheet. Your IOLTA bank account balance should always be the same as your client retainer liability account balance. If it is not, first determine if your trust account has been reconciled with your bank statements. During reconciliation, you can very often identify a missing transfer or other transaction that will bring your accounts back into balance. If that doesn’t rectify the problem, then a deeper dive into your billing and accounting transactions may be necessary.
Trust accounting is the most critical part of bookkeeping for firms. If we were going to explain it to a 5-year-old, we would say that money that is given to you in trust is money that is not yours. So, you should keep all money that isn’t yours in a separate account. Simple as that. These accounts are governed state-by-state and are an incredibly high-risk area for your firm.
One of the harder things about trust accounting is the 3-way reconciliation. First, your balance sheet, trust asset account, and trust liability account balances must match each other. Next, the trust asset account (or IOLTA bank account) must balance back to your bank statement. And lastly, if you have multiple clients for whom you are holding funds, you will need to have a way to determine whose money is whose.
A sub-ledger that details all trust transactions by client or matter is necessary to provide an accurate current balance of the trust funds being held for each client at all times. The total of all the client trust balances should balance back to your trust liability account. That is a 3-way reconciliation.
There is risk around firms getting paid by their clients. In most service industries, you do the work but money must leave your hands to ensure that timekeepers and other vendors get paid to properly provide services to your client. Next the client is billed, but it takes time to collect on those bills. Cash outflow occurs first, then the cash inflows come next, if you’re lucky enough to collect on them. So immediately out of the gate, you’re spending money before the guarantee of being paid back on it.
This is where trust accounting comes in. It helps to mitigate the collection risk by taking funds (retainers) upfront from your clients. By doing so, you have the ability to match the cash-out and in flow. Trusts do require more work on the front end, but they can really improve your cash flow through this process. Additionally, you can better filter out the clients in your book of business who will reliably pay you versus those who will short change or delay paying you.
The first thing you should do if you’re not already doing this is take a step back and look at it holistically. Is trust accounting right for your practice type? Is this something necessary for you to do? If the answer is yes, then your step 1 should start by putting in place the proper internal processes. Think about what happens when a client walks through your door and hands you a check for $10,000 to do work across a 3-month period. What then does your firm do? How would you handle that? Step 2 should be making sure you have a proper separate trust account. And lastly, don’t do everything all at once. Start small, ask for one new client to pay half your estimated bill upfront.
Today, it isn’t enough to just be an expert attorney. You need to have some business savvy too.
But that doesn’t need to be a huge hurdle. By familiarizing yourself with what we discussed in this blog and ensuring that your trust accounts are set up properly and accurately, you will move your firm from the static stage to the growth stage. Sustaining profitability is no easy feat, but with the proper tools and accounting skillset, you are one step closer to making that a reality for your firm.
Prior to 2020, if your firm paid freelancers, contractors, or other non-employees $600 or more during the year, a 1099-MISC would be issued and sent to the payee.
In 2020, the IRS released form 1099-NEC, a new form that will change the way 1099-MISC reporting has been handled for years.
This 1099-NEC was added specifically for reporting non-employee compensation. This will include payments to individuals who are not employees, as well as payments for services to partnerships, estates, or, in some cases, corporations (such as attorneys and law firms).
Yes, the 1099-MISC is still being used, however, it has been redesigned, so it will be especially important to pay close attention to how payments are being reported in early 2021.
Let's take a look!
To start, let's talk about what exactly has changed. To help give you a better visual, below is a chart indicating what exactly has changed between the 2019 form and the 2020 forms:
Any payments in 2020 to attorneys and/or law firms for services rendered should now be entered in Line Item or Box 1 of form 1099-NEC. Gross proceeds, such as settlements paid to attorneys/law firms, should now be recorded in Box 10 of 1099-MISC.
It will be more important than ever to review all vendor settings to ensure that 1099 vendor payments are reported in the correct box and on the correct form in 2020.
Form 1099-MISC must be filed by March 1, 2021, if filed on paper, or by March 31, 2021, if filed electronically. But vendor record review should begin as soon as possible because the 2020 accelerated due date for filing form 1099-NEC with the IRS is on or before February 1, 2021, whether you're using paper or electronic filing procedures.
A best practice to prevent the beginning of the year scramble to obtain missing information from vendors is to require a current W-9 prior to issuing any payments to vendors. This will ensure that each vendor record is set up properly in the accounting system. Further, an updated W-9 should be requested at the beginning of each year, prior to issuing any additional payments, to confirm that the information contained in the vendor record is accurate from year to year.
If you're using a legal practice management software, records and data may look different, but in Centerbase, each vendor has its own record where settings specific to that vendor are located. This makes reviewing and editing the vendor’s 1099 settings a very simple process. Additionally, documents such as the current W-9s can be attached and notes can be entered on a vendor record, making verification of 1099 information quick and easy.
Remember that any credit or debit card payments to vendors should be excluded in what is reported to the IRS since each credit card company (payment settlement entity) reports payments via credit card to vendors on form 1099-K. If credit card payments were to be included in the amounts reported on 1099-MISC or 1099-NEC, it would result in the reporting of the vendor’s income to the IRS twice. This may ultimately result in the necessity of filing corrected 1099’s if requested by the vendor. Centerbase provides the ability to filter out credit card payments from the 1099 vendor report, eliminating the necessity of manually reviewing all vendor payments. This report can be downloaded and used to prepare 1099’s each year.
Preparing for filing 1099’s is going to take some additional effort in early 2021, specifically as it relates to legal settlement accounting. With the filing deadline for form 1099-NEC only 31 days into the new year, getting started on vendor review as soon as possible will be essential.
Now that you are armed with the knowledge of the changes to 1099-MISC and what is to be reported on the new form 1099-NEC, you should be able to accurately conduct 1099 reporting for 2020.
For more detailed information regarding 1099-MISC and 1099-NEC reporting for 2020, check out the IRS instructions.
