There’s A Better Way To Handle Your Legal Accruals
In many legal departments, trying to collect accurate legal accruals on a timely schedule is like playing the worst game of telephone ever created.
Finance emails you asking for unbilled estimates. You email billing departments at dozens of firms. Those billing administrators have to check that all their attorneys have submitted their work-in-progress (WIP). After all of this back-and-forth, you hope they follow up with an email that contains the information you need. If not, you have to chase their estimates with, you guessed it, another email.
You then have to compile all of these documents from all of these firms together into one place. Finally, you send the whole mess to finance, praying nothing has been missed.
Accruals don’t have to involve a tangled web of confused communications. With the right legal spend management tools, legal ops can create a smooth workflow for the finance team to have an accurate, up-to-date picture of legal spend, enabling them to confidently close the books every financial period.
What Are Legal Accruals?
Legal accruals are the estimated costs of legal work performed by law firms, provided by the in-house team to the finance department as part of the accrual method of accounting.
Accrual accounting is a method of financial accounting where revenue and expenses are recorded on the company’s balance sheet in the month in which services are performed. In other words, the date on which an invoice is received or approved is irrelevant.
For example, if legal work is performed by outside counsel in February, it needs to be recorded as an expense in February by the finance team, even if the invoice for that work is submitted in March, approved in April, and paid in May.
In contrast, cash-basis accounting records expenses in the month in which they’re paid and revenues when they’re collected. Accrual accounting is used by all public companies and most private ones.
This is where legal accruals come into play. Since law firms send invoices after the month in which the work was performed, in-house legal teams need to collect legal accruals for work-in-progress from their firms to give to the finance team.
Why Collecting Accurate Accruals Is So Important
Ultimately, collecting accruals is about giving your company’s shareholders an accurate picture of how your business is doing in any given financial period. Shareholders, and your finance team, need a full picture of revenue earned and costs incurred in a period. Legal costs are rarely among the largest costs incurred by a business. However, they still make up a significant portion.
Accruals also give your legal team near-term visibility into legal spend and spend to budget. This information helps you spot areas where spend is higher than anticipated weeks before you receive a legal invoice. Which, in turn, allows you to course-correct with your firms faster.
When you get accrued expenses right, you show your finance team that legal understands business needs and is a savvy financial operator. That’s a surefire way to have finance singing legal’s praises as a business leader. And it doesn’t hurt to be best friends with the department that holds the purse strings come budget season.
On the other hand, when you get accruals wrong, you risk a slap on the wrist for under-accruing or over-accruing. Worse, you’ll eventually be seen as a department that doesn’t understand how to operate like a business.
Why Gathering Accurate Accruals Is So Difficult
Gathering accurate accrual data is difficult because legal teams so many firms to collect accrual information from every month. And each of these firms is instructed on multiple legal matters. The scale of this collection operation is enormous, and the potential for human error is massive.
Here’s just a few obstacles in-house teams face when it comes to collecting accruals.
Your firms may not understand why collecting accurate accruals every month is important to you or how to send accruals to you in the right format. Most law firms operate on the cash-basis accounting method, so they don’t feel the same pressures your finance team does for recording work-in-progress within the month it was performed.
For most in-house teams, the process of collecting accruals is too manual. Each firm sends you a spreadsheet each month. If you don’t have a reliable system in place to remind them, they might forget to send it. Or, you might miss it in your inbox amidst the hundreds of other unopened emails you haven’t gotten to yet.
All of that leads to lots of back-and-forth emails between you and your law firms to track down that spreadsheet. Meanwhile, the pressure mounts for you to collect all these spreadsheets in one place and send them to your finance team before the deadline.
In other words, it’s a massive headache each and every month.
Too Little Time
It’s hard to review those accruals for accuracy and adjust them accordingly when you spend all your time in the days before the deadline just trying to track the spreadsheets down.
That means you’re often delivering inaccurate accruals to your finance team. That leads to bigger true-ups and that’s not a great way to make fast friends with the folks in accounting.
Most in-house legal professionals have not been trained in finance and accounting principles, so it’s hard to get your head around the concepts and terms. That leaves you wondering exactly what data your finance team needs, why, and the best format in which to report it.
Legal work is not like other, more stable forms of business expense. In other departments, you might know you need to order 1,000 pens every six months. It’s predictable.
In the legal department, you’ll have some matters that report legal spend this month but not next month. That means you need to know what’s going on with every matter as you review each accrual.
Avoiding Incorrect Legal Accruals
If your accrual estimates are too low or too high (also known as under-accrued or over-accrued), then the finance team must complete a “true-up” in a future month to make the books right.
Small true-ups are common and not a big deal. Big true-ups, however, can be painful. It’s especially bad if a big true-up coincides with the end of a fiscal quarter or, worse, the end of a fiscal year. One reason is that under-accruing or over-accruing can affect bonus calculations for employees. The bigger problem is that they can affect public disclosures and stock prices.
While an in-house team member getting fired for under- or over-accruing might sound extreme, it’s not unheard of. Accuracy is paramount for in-house teams, the finance team, and ultimately the company’s shareholders.
The best legal teams collect comprehensive accruals every financial period and leave time in the collections calendar to review them for accuracy. After all, firms can sometimes add an extra zero to the accruals for one matter, resulting in a significant over-accrual.
On the other hand, certain outside counsel attorneys may forget to log their hours in their internal time tracking tool by the accrual deadline, leading to an under-accrual. When the in-house team reviews the accruals, they can use their knowledge of which matters have a heavy or light workload to spot such under- or over-accruals before they lead to true-ups in future financial periods.
How to Improve Your Legal Accrual Management System
Improving your accrual management system starts with clearly communicating your expectations and processes to law firms. You must impress upon them how important accruals are to you, and why they need to be on time and accurate.
Explain that part of how you judge outside counsel’s performance is through timely, accurate accruals.
Then, help law firms serve you better by automating accrual collection and reporting. Automated reminders to your outside counsel makes it way easier for your firms to remember to submit accruals on time. Automated follow-ups, with clear cutoff dates included, keep your needs top of mind for outside counsel, too.
You need legal spend management software that sends these automated reminders and that accepts bulk uploads from your firms so they can finish the work quickly and all in one go.
All this automation also saves your legal ops team the headache of chasing down law firms for that last accrual on a single, overlooked matter.
Legal spend management tools like Brightflag make it easy to collect all those accruals. But it also allows them to be analyzed. And for the reports your finance team needs to be produced in exactly the format they’re looking for. Brightflag can gather those accruals along with approved, rejected, and pending invoices to give the finance teams an up-to-date and accurate look at your spend.
Be a Better Partner to Your Finance Team with Improved Accrual Management
By embracing improved accrual management practices, you’re not just tidying up the legal department’s books. You’re actively contributing to the overall financial health and transparency of your organization.
Accurate and timely management of legal accruals bridges the gap between legal operations and financial reporting. It gives your finance colleagues a clear and current picture of the company’s fiscal position, helping them make informed decisions and forecasts. This collaborative effort, supported by tools like Brightflag, paves the way for a better partnership between legal and finance teams.
Imagine a future where under- or over-accruing is a rarity rather than the norm. And where legal and finance teams rely on data-driven insights for planning and strategy. This is the power of improved accrual management. It transforms how your department is perceived, elevating it from a cost center to a value driver within your company.
It’s time to redefine the relationship between legal and finance, and it starts with better accrual management. Schedule a demo with Brightflag to discover how to make this transformation a reality.