Main Accounting Services’ mission is to empower law firm owners to understand their finances – and provide the peace of mind that comes with having professional partners to assist with accounting functions.
One of the keys to managing your firm’s finances is to become familiar with standard accounting terms. This is especially critical if you are not working with an experienced accountant or bookkeeper. And even if you are, the information they provide will be significantly less valuable if you do not know the fundamentals.
Taking the time to learn the following terms will give you greater insight into how to keep your firm’s operations running smoothly – and help you make better financial decisions.
Balance Sheet
The balance sheet shows all assets, liabilities, and equity. It is often more important than the Profit and Loss statement as it shows ALL financial activity. All balance sheet accounts should be reconciled on a regular basis to ensure accuracy.
- Assets are usually bank accounts and fixed assets such as equipment.
- Liabilities are what you owe, including credit card, Line of Credit, and loan balances.
- Equity shows the investment in the business and retained earnings. Retained earnings show the company’s cumulative net earnings since the beginning, and also include shareholder (owner) distributions. Main Accounting ensures the equity section of the balance sheet is reconciled to prior years’ tax returns.
Profit and Loss
Also known as the Income Statement, a Profit and Loss statement shows income and expenses. The chart of accounts structure is important so the report makes sense. For example, Main Accounting structures the Profit and Loss so our clients can view the percentage of income being spent in four major categories (Client Costs, Employee Costs, Marketing, and Administration). It’s important to understand WHERE income is being spent. Some of our clients want to see income designated by revenue source and others want to see it broken out by services provided. NOTE: If your profit and loss report shows a profit, that doesn’t mean you have the cash to keep the business running. Creating and managing a cash flow forecast can help business owners understand where all their money is going.
Statement of Cash Flows is a financial report that shows the beginning cash balance plus money in, less money out and ending cash balance for a given period of time.
General Ledger is a report that shows all transactions for all accounts included on the Balance Sheet and the Profit and Loss statement.
Trust Reconciliation
Most state bar associations require a law firm to create and maintain client trust reconciliations on a monthly basis. These are often referred to as “Three-way” reconciliations:
- Bank Balance – reconciling your bank balance to your books is essential. The bank reconciliation will include any uncashed checks or undeposited funds.
- Book Balance – The bank balance on your books is listed as an asset and should ALWAYS match the client trust liability balance.
- Balance by Client – The reconciliation should be broken down by individual client balances.
Additionally, all transactions should be detailed by client. All deposits and withdrawals should be identified with a client name so you can produce a client’s ledger activity. Main Accounting Services also recommends reconciling the client balances on the books to the law firm’s billing software to ensure the billing software trust balances also tie out to the bank activity. To read more about trust reconciliations, see our recent blog.
(ADD LINK TO BLOG when posted on the website)
Bank Reconciliation
Reconciling bank accounts is critical to ensure all transactions are accounted for. Much like we used to do with bank books, we would write all of the checks issued to get a clear picture of what our account balance would be if all the outstanding checks cleared. We recommend reviewing the outstanding check list on a regular basis to ensure the books’ bank balances are accurate.
Budget/Forecast
Creating a detailed budget will allow you to make a plan for the upcoming year including marketing initiatives, hiring new team members, and growing revenue. Budgets are usually created in October for the upcoming year, and estimating your revenue will allow you to plan for expenses that you can afford. Of course, best laid plans don’t always work out. That’s why Main Accounting Services converts annual budgets into monthly forecasts, essentially updating the budget with everything we know to date. If you didn’t plan on hiring a new attorney when you did the budget, but now you have signed a large client and expect more revenue, then you will want to see the impact of the additional revenue and expenses attributed to the addition of new attorney. With this method, we can predict at any given point in the year what your gross profit for the year will be.
Cash Flow Forecast
Done properly, a cash flow forecast should be a prediction of how much cash you will have available in the future at the end of any given month. Main Accounting Services has a robust program that allows us to provide reliable indicators of when you may experience a cash crunch.
Accounts Receivable (AR) is a list of invoices that have been issued to clients/customers but have not yet been paid. Companies that review balance sheet reports on a “cash basis” may not see any balances in this account, as funds have not yet been received.
Accounts Payable (AP) is bills owed to vendors that have not yet been paid. Companies that review balance sheet reports on a “cash basis” may not see any balances in this account, as bills have not yet been paid.
Payroll
Main Accounting Services recommends using a third-party payroll software such as GUSTO. Payroll software companies are well equipped to pay quarterly tax payments and maintain records necessary for tax and regulatory purposes. There are two types of employees:
- W2: An employee of a company where federal and state taxes are withheld and submitted to the tax agencies on a regular basis. Note that W2 employees can be salary exempt from overtime, salary non-exempt from overtime, hourly, and seasonal.
- 1099: Independent contractors where no taxes are withheld, but 1099 forms need to be reported to the IRS.
It is important to understand the differences before making a job offer or signing a contract (this article from the IRS may help.) If you are not sure which classification you should use, consult with an accountant or employment attorney to make sure the employee is set up properly.
Main Accounting Services understands the challenges and importance of maintaining solid financials. By providing insightful information, accurate and timely reports, and financial explanations customized to meet your needs, we are here to support your firm’s success and profitability. If you are looking for professional partners to help increase the success and profitability of your growing firm, click here to schedule a consultation.