In an effort to save some money, a well-intended small law attorney had been managing his own books. Now the auditing committee from the state bar association was taking a look – and couldn’t make sense of the data.
Given her expertise with accounting software, and a history of teaching accounting at the university level, the auditing committee called Gale Kirsopp. She was able figure it all out that time, but she bumps into law firms in hot accounting water far too often.
That call came in six years ago and leading her down the path of “trust accounting clean-up work” and eventually to CEO of the 4700Group. Typically these projects – predicated by an attorney managing the books DIY-style, or a law firm that hires an accountant without legal experience – don’t have a superhero-to-the-rescue ending.
“The consequences are very steep,” she said in an interview.
Ms. Kirsopp recently signed on as an advisor to the LexisNexis Firm Manager® team, as it prepares for the Intuit QuickBooks® Connect conference November 2-4, 2015 in San Jose (booth #C31). The team is building out technology integrations and program for the QuickBooks ProAdvisors participants that serve the small law market.
The Business of Law Blog caught up with her to ask her about some of the issues surrounding accounting and small law firms. She introduces accounting to law firms from a “useful” tool as opposed to merely a “tax” requirement. What this means is translating numbers into useful operational insight that a managing partner can act on to improve a law firm’s outlook.
The Top Law Firm Accounting Challenges
The accounting challenges Ms. Kirsopp raises aren’t typical. She points to technology – especially with cloud tools – where software has become so easy to use, lawyers feel increasingly comfortable. Too comfortable when it comes to accounting, she notes.
Sure law firms can generate reports, but do really understand “what the software is telling them?” Are the numbers realistic?” she asks. “Have the numbers been validated?”
She points to a simple income statement. A law firm might see net income showing growth– but the figures don’t match what’s in the firm’s checking account. It’s at this point an attorney might ask, “If my firm made that much money, how come my account doesn’t show it?”
Ms. Kirsopp outlines two solutions to this challenge. First, an attorney can take the time to learn accounting. She says now and again she finds a lawyer that is genuinely interested or enjoys pouring over the numbers.
Most attorneys however, do not prefer that option. Attorneys go to law school to practice law rather than crunch numbers in spreadsheets. For those in the latter the best advice is to hire a good accountant.
She qualifies this by noting the accountant hired should be a trusted advisor as opposed to a bookkeeper. Relationships are important so a lawyer can feel comfortable talking about numbers and the implications for law firm strategy.
There’s another distinction for law firms: many bookkeepers understand accounting software, but they may not understand law firm practice management software.
Getting Paid: Top Metrics to Track
The difference between net income and cash, raised above, points to one underlying financial document: the cash flow statement, the link between the income statement and the balance sheet.
To that end, the key metrics Ms. Kirsopp recommends law firm partners focus on are related. She suggests these three:
- Time to Bill. This measures how long it takes for partners to bill clients. In a law firm billing survey conducted by LexisNexis, about 15% of small law attorneys noted the firm ran into collections challenges when a bill was rendered for services too far in the past.
- Account receivable turnover ratio. AR turnover ratio represents the average number of days it takes clients to pay the legal bill. “If it takes too long,” she says, “it’s effectively an unsecured loan without interest.” She notes law firms with clients 30, 60 or 90 days in arrears, will often offer discounts as an incentive for prompt payment. Discounting past due accounts is akin to rewarding bad behavior. “There are ethical ways to collect on bills,” she notes. “But they didn’t go to school to do accounting.” Some 73% of small law firms experience past due bills according to the billing survey, and law firms that discount tend to have more past due clients. About half say the chances of collecting on a bill 90 days or older is unlikely or very unlikely.
- Cash flow. “It doesn’t matter how much revenue you generated if it takes 90 100, 120 days to get your payment,” she says. “Many firms have gone bankrupt not because of revenue but because they weren’t getting paid.” Understanding what a statement of cash flow is and how to use it in managing a practice is paramount.
When Should Small Law Engage an Accountant?
Ask any experienced small business owner for advice, and most will list hiring a good accountant among the top recommendations. Likewise, Ms. Kirsopp recommends lawyers engage a tax accountant “as soon as they open doors.”
An operational accountant, one with law firm experience, is incredibly helpful for answer in important strategy questions. For example, “What’s a fully burdened cost of hiring a paralegal or a contract attorney?”
She says many small law firms fall into one of two camps – those that are just happy to “turn it over to the first volunteer” and those with a predilection for DIY. Both approaches can lead to mistakes. The trust accounting audit above is one example, and the other is simple math.
If an attorney spends five hours a week on accounting, but bills at $250 per hour, he or she is in essence paying $1,250 a week for less-than-expert accounting services. For those attorneys that say they do it at night, she points to quality of life and family time as a drawback. And spreadsheets are liable to get blurry around 10 p.m. in the evening.
“What you will gain by hiring an accountant will by far pay over and above any amount of money you think you’d save via DIY.”
Considerations for Hiring a Law Firm Accountant
Ms. Kirsopp has worked with a range of law firms, from the solo-attorney hanging out a shingle, to the litigation superstar leaving a large firm to venture out on his or her own. She offers a few key considerations.
1. Relationships matter. Law firms are well served seeking an accountant that can translate numbers into insight with operational value – that is how to improve law firm performance.
2. Law firm experience required. The legal market operates within “very unique requirements as dictated by bar associations,” she says. There are strict codes dictating how to manage trust accounts for example. Understanding how accounting software integrates with practice management is critical knowledge a law firm accountant should maintain.
3. Understand accountants come in many forms. Just as law firms have many evolving models, so too do accounting firms. There are firms that will work onsite, virtually, or outsource the work overseas. Similarly, there are forms that strictly focus on bookkeeping at one end or oversight accounting work at the other. Fees too can come in all sizes, including retainer, flat-fee and hourly billing models.
“Hiring an accountant is two-fold,” says Ms. Kirsopp. “Someone you’re comfortable with and someone who has focused on attorneys.”
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The LexisNexis Firm Manager team will be exhibiting at the QuickBooks Connect conference in booth #C31. For more information on Firm Manager program for the QuickBooks ProAdvisors participants, please visit: www.firmmanager.com/proadvisor
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