Accounting terms may sound like German to most law firm owners and bookkeeping professionals may be using several key terms without realizing that some may not know what they mean or the importance in your law firm. Firm owners are not expected to understand all the ins and outs but understanding these basic terms will help understand what is happening financially in your firm.
General Terms
Accrual-basis accounting method: When using this method, income is recorded when earned, regardless of when the money is actually received, and expenses are recorded when they’re billed.
Cash-basis accounting method: When using this method, income is recorded when received and expenses are recorded when money leaves your account.
Forecasting: This is the process of using your firm’s historical financial information to predict your future trends. This is beneficial in estimating budgets and establishing goals for revenue, expenses, and net income.
General ledger: This the recording of your firm’s financial transactions over the life of your firm.
Chart of accounts: This is the list of your firm’s financial accounts where all transactions are recorded to. Each of these financial accounts feed into the financial statements for your firm.
Law Firm Specific Terms
Interest on Lawyers Trust Accounts (IOLTA): This is a bank account designed to keep client funds. When interest accrues in these accounts it is forwarded to the state bar. Each state has varying regulations regarding the use of IOLTA’s.
Trust accounting: This is the process of accounting for client funds by client. These unearned fees are usually paid as a retainer, settlement, court fees or advanced costs.
3-Way reconciliation: This is the process of verifying your financial data by checking the bank account reconciliation, trust account reconciliation and client trust ledger ensuring they are all accurate and match the appropriate system.
Balance Sheet Terms
Balance Sheet: A financial statement that reports assets, liabilities, and equity of your firm.
Asset: Anything your firm owns that has monetary value.
Liability: All debts that a company has yet to be paid off.
Equity: When you subtract your assets from your liabilities, you are left with your equity.
Accounts payable: These are expenses that are due (incurred and not yet paid). This is a liability.
Accounts receivable: This revenue that has been invoiced but not yet received. This is an asset.
Income Statement Terms
Income Statement: A financial statement that shows the revenue, expenses, and net income over a given time-period. This may also be referred to as the Profit and Loss (P&L) Statement.
Cost of Services Sold (COSS): These are expenses that are directly related to providing your services.
Depreciation: This is the loss of value in an asset over time.
Bad debt expense: If you are unable to collect on an invoice, you can enter the amount as a bad debt expense.
Statement of Cash Flows Terms
Statement of Cash Flows: A financial statement that reports all cash inflows and outflows of your firm. This includes the cash received from operations and external investment sources and payments for business activities and investments during a given period.
Cash flow: This is the net amount of cash and cash-equivalents being transferred into and out of your firm. A positive number specifies that more cash flowed into your firm than out, whereas a negative number specifies more cash flowed out of your firm.
Operating cash flow: This is the cash that is being made and spent through operating your firm.
Cash flow from investing activities: This is the cash used to buy or sell long-term asset investments.
Financing activities: This is the cash received from or paid to lenders, other creditors, and investors in your firm.
These terms will give you more of an understanding of your finances within your firm. If you would like to learn more about what we discussed in regard to the financial statements and how to understand them, click here.
Next week, we will be discussing bookkeeping tips.