Law Firm Financial Management – Practical Tips & Suggestions – Part II

By John W. Olmstead, MBA, Ph.D., CMC

Managing the firm’s finances is one of the most important management roles in a law firm. Effective financial management is a critical success factor and determines whether a law firm is financially successful. General partners, managing partners, firm administrators, and firm accounting managers or bookkeepers must do all they can to stay abreast of law firm financial management best practices that are being used in the legal industry.

This is part two of a multi-part series of practice tips and suggestions that will be published from time to time.

Job Description for A Bookkeeper – Small Law Firm

The bookkeeper is the lifeblood in a small law firm. Therefore, it is important to structure the position properly and hire the right person for the job. Here is an outline of a bookkeeper position for a small law firm.

Position Summary

The primary function of the bookkeeper position is to perform the billing, bookkeeping and accounting functions of the firm. This position requires an experienced and accomplished person with a strong bookkeeping and computer background. The position requires skills and experience in bookkeeping, accounting, law firm billing and QuickBooks software as well as Microsoft Office Products. The position requires experience in a law or other professional service firm environment.

Reporting Relationship

This position reports to the firm owner or partners.

Required Knowledge, Abilities and Skills

1. Must have at least 2+ years bookkeeping experience as a full-charge bookkeeper with
   responsibilities including client billing in a law or professional service firm environment.
2. Must have successfully completed coursework in bookkeeping/accounting. An associate
   degree in bookkeeping/accounting is desirable.
3. Must have experience with law firm billing or other professional service firm (Timeslips or
   appropriate software that the firm is using) and accounting software (i.e. QuickBooks) as well as Microsoft Office Products.
4. Must possess strong administrative and organizational skills.
5. Must have strong interpersonal and communications skills.
6. Professional appearance and manner.

Duties

 

1. Perform all bookkeeping functions
2. Performs all client billing functions and other accounts receivable functions
3. Pay vendor bills and manage accounts payable.
4. Perform all data entry of cash receipts and client costs in billing and accounting systems.
5. Perform all data entry of cash receipts and disbursements for the IOLTA trust account in the
   accounting systems.
6. Process credit card transactions.
7. Reconcile bank statements.
8. Work up and make bank deposits for the operating and IOLTA accounts.
9. Handle payroll.
10. Handle Insurance
11. Provide all required financial reports to the firm owner on a monthly basis.
12. Filing.
13. Coordination with the firm’s accountants.
14. Management and oversight of the billing and accounting systems.

Contingency Fee Profitability: Can You Make Money from Contingency Fee Work

Contingency-fee work can pose major risks for law firms, as they earn no fees if they lose those cases and sometimes have profits deferred in protracted litigation. In addition, cases can be lost with no fee whatsoever received. Whether a firm is considering “big deal” litigation or bread and butter run of the mill personal injury litigation here are suggestions that we offer to firms:

1. Don’t dabble in contingency fee work. Take it seriously and insure that your case portfolio is adequately diversified.
2. Reduce case portfolio risk and improve case profitability by implementing a sound case intake system to ensure that you are selecting quality cases.
3. Realize that you have to spend money to make money and that you simply may not have the financial resources to take on certain cases. Learn how to say no and when to refer these cases out to others.
4. Insure that you have an adequate portfolio of cases (number of cases, size and type) to insure diversification and manage risk.
5. Analyze the profitability and return on each case and ascertain what can be done differently on future cases. Typical metrics include effective rate and/or LODESTAR.

The fundamentals of risk and return are at work and should be considered when accepting contingency fee work. You are betting that you can beat your hourly rate that you receive (or would receive) on hourly work. Contingency fee work often involves the risk of no fee at all, financing the case, long time periods before the case is concluded and fees are received, client advance investments, etc. For these risks the firm should be able to expect a premium. In other words – the effective rate on contingency fee cases should (on average) be greater than that for hourly work.

Many law firms are not receiving a “risk premium” at all and are often, on average, obtaining an effective rate close to their bill rate. So, do consider the risk involved and evaluate methods of mitigating the risk as much as possible. In general – don’t dabble – but work to a portfolio of cases large enough to diversify your risks.

Herbert Kritzer has done extensive academic research over the years on contingency fees which can be found in his book – Risks, Reputations, and Rewards: Contingency Fee Legal Practice in the United States. The book can be ordered from Amazon.com.

While I have outlined a cautious approach here I want to also clarify that I have many clients that are doing very well and making a lot of money doing contingency fee work. It is the firms that did not grow up doing contingency fee work that “dabble” where I see the problems.

So, proceed with caution – but go for it if it makes strategic sense for your firm.

Law Firm Financial Statements – Profit vs Cash Flow

Getting a handle on the financial aspects of your firm is the most important role for firm administrators and managing partners.

Firm management should be receiving a balance sheet which reflects the firm’s financial position as of a point in time. The income statement only reflects income and expense accounts and reports net income for a reported period. The income statement is different than a statement of cash flows which reports cash flows during the period. Partner draws, client advances, and line of credit payments are not expense accounts (they are asset, liability, and capital accounts respectively).  Consequently, they will not be reported on the income statement. These accounts will be reported on the balance sheet.

Other than reviewing the balance sheet for activity in accounts such as discussed above the balance sheet (without adjustment) has limited use. Its purpose is to reflect the firm’s financial position as of a point in time. However, since most law firms maintain their books on a cash basis – the largest assets – accounts receivable and unbilled work in process – are not reflected. Accounts payable and other such liabilities are not reflected either. If you are interested in a true picture of the firm’s financial position as of a point in time you must take these items into consideration.

Another report that you may wish to receive is a statement of cash flows. This statement will report actual flows of all cash – in and out of the firm – regardless of account type. There are additional schedules and reports that you should receive as well. Suggest you review your system and create a report distribution policy as to which reports you and the other partners receive each month.

Balancing the Law Firm Trust Account

 Failure to properly manage, balance, and reconcile the firm trust account can be a major problem for law firms – from professional responsibility, accounting, and tax aspects. From a bookkeeping standpoint – failure to maintain a trust account sub-ledger for each client that has money in the trust account and insuring that all the sub-ledgers balance and reconcile back to the trust account bank statement in the biggest problem that I see. You must do more than simply maintaining a checkbook journal register – you must have a sub-ledger for each client. If the firm reflects the trust bank account on its balance sheet there should be either a contra asset account or a liability account reflecting the same amount reflected in the cash account. The total of all the sub-ledgers should also equal the number in each of these two general ledger accounts. All should reconcile back to the trust account bank statement. If the firm does not reflect the trust account on the balance sheet – then the trust account bank statement should be reconciled to the sub-ledgers.

Many time and billing programs have trust accounting modules that fully automate the trust accounting management function, maintain the sub-ledgers, write trust account checks, and reconcile the bank statement against the client trust sub-ledgers.

There is a whole array of issues that law firm need to be aware of and stay on top of concerning retainers generally, firm trust accounts, and other matters. Managing partners, administrators, a firm’s bookkeeper, and the firm’s CPA need to get educated on all of the ramifications.

Here are a few additional suggestions:

1. Get a copy of your local rules of professional conduct concerning trust accounts and read them.
2. Insure managing partners, administrators, bookkeeper, and the firm CPA read these rules and implement appropriate systems to ensure compliance.
3. Purchase the book, ABA Guide to Lawyer Trust Accounts, by Jay Foonberg. Book can be obtained from the American Bar Association website.
4. Reconcile monthly.
5. Use appropriate software to write checks, record deposits and transfers, reconcile bank statements, and maintain the client trust sub-ledger.
6. Maintain a journal.
7. Maintain a client trust sub-ledger.
8. Insure that funds are transferred to the firm’s operating account when fees are earned and appropriate accounting entries made at that time in the firm’s books.
9. Stay on top of the trust account.
10. Insure that bank and credit card companies are following proper procedures. Insure that the firm’s bank takes services charges, charges for printing checks, etc. from the operating account rather than the trust account.

Law firms should get a handle on this sooner than later. Managing partners, administrators, bookkeepers, and the firm CPA should get educated on the rules and procedures, and implement appropriate policies and systems now. It is always easier to prevent a mess than to clean up one.

Until next time.

John W. Olmstead, MBA, Ph.D., CMC, is a Certified Management Consultant and the president of Olmstead & Associates, Legal Management Consultants, based in St. Louis, Missouri. The firm, founded in 1984, serves clients across the Globe assisting them with implementing change and improving operational and financial performance, management, leadership, client development and marketing.

John is the author of a recently published book, The Lawyers Guide of Succession Planning: A Project Management Approach for Successful Transitions and Exits. Published by the American Bar Association, John was the Editor-in-Chief of “The Lawyers Competitive Edge: The Journal of Law Office Economics and Management,” published by Thomson Reuters for 24 years.

Additional articles and information is available at the firm’s web site: www.olmsteadassoc.com and blog www.olmsteadassoc.com/blog

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