Bookkeeping for Law Firms: 10 Best Practices to Stay Compliant and Profitable
Disclaimer: This article is for informational purposes only and does not constitute legal, tax, or financial advice. The content provided is general in nature and may not apply to your specific situation.
Running a law firm involves more than just practicing law.
Missteps in trust accounting or financial management can lead to serious consequences—including fines and penalties, disciplinary action, or even disbarment.
Unlike traditional small businesses, law firms manage unique financial structures such as trust accounting. As such, bookkeeping is a cornerstone of ethical legal practice and its importance cannot be overstated.
In this article, we outline ten best practices in bookkeeping that every law firm should implement to ensure compliance and promote long-term success.
1. Maintain a Separate IOLTA (Trust Account) from Operating Funds
Law firms routinely receive funds that must be held in trust, including client retainers, settlements, and escrow deposits. These trust funds are required to be kept separate from the firm's operating funds in a designated account known as the Interest on Lawyers Trust Account (IOLTA).
It is imperative that law firms understand and follow their state's specific compliance requirements for maintaining separate trust funds. The consequences for noncompliance can be severe, including substantial fines, disciplinary penalties, or in worst-case scenarios, disbarment.
2. Perform Monthly Three-Way Reconciliations on the IOLTA
Firms are generally required to conduct regular three-way reconciliations for their IOLTA on a monthly or quarterly basis, depending on their state's requirements.
A three-way reconciliation reconciles the following:
Bank Statement: The actual bank balance in your trust account
General Ledger: The total trust liability for the firm as reported in the law firm's accounting software
Client Subsidiary Ledgers: Individual balances held for each client or matter
Performing these reconciliations on a monthly basis is widely considered the gold standard, even if your state has less stringent reconciliation requirements.
3. Create a Well-Structured Chart of Accounts (COA)
You should be using a chart of accounts that is specifically tailored to law firm operations.
Some of the accounts that are unique to law firms include:
Unbilled Legal Fees - Asset account for income earned but not yet billed to clients
Client Disbursements Receivable - Asset account for billable expenses paid by the law firm on behalf of clients
Partner's Equity - Includes capital invested by partners in the firm and earnings not yet distributed to partners
Legal Fees (categorized by practice area) - Income account for revenue
Trust Account Liability - Liability account for holding trust funds from clients such as retainers and escrow funds
Review your COA routinely to ensure it remains aligned with your services and reporting needs.
4. Implement Structured Invoicing Processes
Effective client invoicing is a critical component of a law firm's financial health. Implementing structured billing processes improves cash flow, enhances client relationships, and boosts firm profitability.
Law firm invoicing should include:
Regular Billing Cycles - Make sure invoicing occurs at the same time each month.
Progress Billings - Clients should be invoiced at monthly intervals based on the accumulated billable hours for the month.
Client Billable Expenses - Document and invoice clients promptly for reimbursable expenses. Make sure you are carefully evaluating contingency-based expenses before invoicing.
Invoice Quality Control - Implement a process for ensuring that invoices are reviewed by the partner on the case prior to sending out to clients.
5. Review Financial Reports Regularly
Partners in the law firm should be regularly reviewing their financial reports in order to ensure that they are making informed decisions based on accurate and timely information.
As such, partners should review the following reports on a monthly basis in order to identify trends, potential risks, and opportunities for growth:
Profit & Loss Statement (P&L)
Balance Sheet
Cash Flow Statement
Aged Accounts Receivable Report
Trust Account Ledger (by client)
Billable Hours Summary
Matter Profitability Report
Budget vs. Actual Report
6. Create & Track Law Firm-Specific KPIs
Tracking Key Performance Indicators (KPIs) gives you a pulse on firm productivity and profitability.
Some of the essential financial KPIs that law firms should be tracking include:
Utilization Rate = Billable Hours / Available Hours
Realization Rate = Billed Time / Recorded Time
Collection Rate = Collected Revenue / Billed Revenue
Cost Recovery % = Reimbursed Costs / Costs Advanced
By reviewing KPIs monthly, you can spot inefficiencies and course correct when needed. Many cloud-based dashboards integrate KPI tracking automatically.
7. Prepare a Comprehensive Annual Budget
Law firms should prepare a comprehensive annual budget and conduct monthly variance analysis comparing budgeted figures against actual results. This enables firms to identify trends early, spot potential issues before they become problematic, and make informed strategic adjustments throughout the year.
Regular variance analysis provides valuable insights into operational performance, allowing leadership to answer critical questions. Unlike dynamic forecasts that are updated throughout the year to reflect changing conditions, budgets serve as a fixed benchmark that represents your firm's initial goals and expectations. This stability makes them particularly valuable for measuring progress and maintaining accountability across all levels of the firm.
8. Maintain Proper Expense Tracking
Law firms frequently advance expenses on behalf of clients, including filing fees and court costs. These disbursements must be tracked meticulously to ensure accurate billing and ethical compliance.
Some ways that law firms can achieve this include:
Implementing expense management software
Creating separate client disbursement accounts to track costs
Establishing clear policies and procedures surrounding client disbursements
Reviewing and reconciling client disbursements on a monthly basis to ensure accuracy
Invoicing clients promptly for disbursements to maintain healthy cash flow
9. Implement Billing Procedures
Accurate time tracking is essential to law firm profitability.
It is important to use an integrated time-tracking software to ensure that you are accurately logging time for both billable and non-billable hours.
Reliable time data improves invoicing, productivity tracking, and client profitability analysis.
10. Establish Effective Collections Processes
Even with timely invoicing, collections require dedicated attention and follow-up. Implementing structured collection processes improves cash flow and firm financial stability.
Effective collections management should include:
Automated Payment Reminders - Send friendly reminders when invoices approach due dates
Clear Payment Terms - Clearly communicate payment expectations in engagement letters and on invoices
Multiple Payment Options - Offer credit card payments, ACH transfers, and traditional payment methods
Regular AR Reviews - Conduct weekly reviews of aging receivables and take prompt action
Documented Collection Procedures - Create a standardized process for following up on overdue accounts
Final Thoughts
Effective bookkeeping does more than organize your finances—it protects your license, supports firm growth, and builds client trust.
By implementing these 10 best practices, your law firm can:
Stay compliant with state bar rules
Strengthen financial stability
Operate more strategically
Ready to Take Bookkeeping Off Your Law Firm's Plate?
The Accountant's Palette offers virtual accounting, bookkeeping, and advisory services tailored to law firms.
Let us help you get back to what you do best—practicing law.
Book a Free Consultation to learn how we can support your firm’s financial health.
