Client accounts: Opportunity, obligation and the risks in between

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Posted by Robert Banner, a council member of the Institute of Legal Finance and Management (ILFM), a Legal Futures Associate

Banner: Clients will suffer if firms lose interest income

In this, my third and final blog on the ILFM’s collaboration with Crowe and its annual Law Management Benchmarking report (see the first two here and here), I want to look at the findings concerning client accounts, including the financial opportunities they present, the compliance obligations they carry, and the risks which arise when the two aren’t properly balanced.

Of particular note is the finding that nine in 10 law firms say that they could not operate without a client account.

This is, of course, a time of great uncertainty for client accounts and the interest derived from them as a result of work by first the Solicitors Regulation Authority (SRA) and then the Ministry of Justice.

Without going into the detail, what I will say is that – in very simplistic terms – if client interest is lost, there is a great danger that clients will be the ones to suffer.

I believe law firms would either raise their fees or reduce the investment they make in developing their practices, or a bit of both. Either would be bad news for clients.

I very much hope, therefore, that the end result is a favourable one for the profession and that the contents of this article remain relevant for the foreseeable future.

So, let’s turn to the benchmarking report.

Interest income: an under-explored opportunity?

One of the more striking findings in the Crowe report is that almost half of firms reported an increase in client account interest income, despite a general reduction in interest rates during the period.

This suggests that firms are either holding larger balances for longer, benefiting from improved banking arrangements, or both.

Yet only 23% of firms are currently using long-term client deposit accounts. For many finance teams, this raises a legitimate question: are firms leaving money on the table?

In practice, the answer is more nuanced than it first appears. Many firms make a deliberate decision not to actively maximise interest returns – and there is a sound compliance reason for doing so.

The classification of interest income has implications for VAT partial exemption calculations, and missteps in this area can introduce additional complexity and cost.

Firms considering whether to change how client balances are managed – whether by moving funds into longer-term deposit accounts or negotiating enhanced rates with banking providers – should take specialist VAT advice before doing so, rather than treating it purely as a financial optimisation decision.

The broader principle is that any changes to how client funds are held must be assessed in the round – considering regulatory obligations, client obligations and tax implications together, not in isolation from each other.

When lock-up inflates interest income

The report also reveals a less obvious dynamic that is worth examining carefully. Where a firm’s lock-up position is poor – meaning bills are raised late, cash collection is slow and unbilled work sits on the ledger for longer than it should – client account balances may inadvertently be higher than they need to be.

Higher balances generate more interest income, which can make the firm’s financial position look marginally better than it is.

This creates a subtle but genuine risk: interest income masking underlying inefficiencies in billing and cash collection. A firm that is receiving a reasonable interest return from its client accounts may be less motivated to address the lock-up issues that are causing those balances to accumulate in the first place.

For example, take a firm where a significant conveyancing matter has completed but billing has been delayed.

The client funds remain on account longer than necessary, generating interest that flows through to the firm’s income. On the surface, the numbers look acceptable. In practice, the firm has a cash collection problem that the interest income is partially concealing.

From a financial management perspective, interest income should support a firm’s finances but it should not be relied upon to offset operational weaknesses.

The priority should always be improving cash conversion and reducing unnecessary balances, not optimising returns on balances that should not be sitting in the account in the first place.

Operating within the framework

Client money is not a commercial asset in the traditional sense, and the regulatory framework reflects that. Legal finance professionals operate within clear obligations:

Client money must be held securely and in accordance with the SRA accounts rules, with the client’s best interests paramount at all times.

Interest must be calculated and allocated correctly, both to clients where it is due and to the firm where it is legitimately retained. Reconciliations must be accurate, timely and properly documented.

And any decision about how client funds are held – including the use of different deposit structures – must be considered in the context of those obligations, not just the potential financial return.

What looks like a straightforward financial optimisation exercise can become a compliance issue quickly if it is not properly governed.

The question finance teams should be asking is not simply ‘could we earn more on these balances?’ but ‘can we do so within the rules, and have we properly considered all the implications?’

What finance teams can do

The Crowe report highlights both the risks and the opportunities in client account management, and points to a clear role for finance teams in navigating them.

Reviewing banking arrangements is a reasonable starting point. Are current deposit structures appropriate? Are there opportunities to improve returns within the rules? Has the VAT position been properly assessed in light of any changes under consideration?

Internal policies around interest calculation and allocation deserve regular review, not just to ensure compliance but to ensure consistency. Where policies exist only in practice rather than in writing, a change of personnel can expose the firm to risk.

There is also a broader opportunity for finance teams to add value at a firm level. Client account data – analysed alongside lock-up, billing and cash flow information – can provide genuine insight into where inefficiencies lie and where management attention is needed.

Finance professionals who can present that analysis clearly, and connect it to the firm’s commercial performance, are doing considerably more than maintaining compliance. They are contributing directly to the firm’s financial health.

Bringing the series together

Across these three articles, a consistent picture has emerged from the data. The profitability gap between well-run firms and the rest is not primarily a function of size, location or practice area – it is a function of financial management.

Firms that manage lock-up and cash flow rigorously, that govern client accounts carefully and that invest in the compliance and finance function tend to outperform those that treat these areas as administrative overhead.

Legal finance and compliance professionals sit at the centre of all of this. The ILFM’s role is to support those working in these roles – through training, resources and a community – so that they are equipped to meet both the regulatory expectations of today and the evolving challenges ahead.

I finish this series of three articles very much as I started. The importance of confidential benchmarking surveys is huge. I hope that all who have read the articles have found them interesting and thought-provoking.

But to all those involved in law firm management, take those thoughts further. Consider in detail how your firm compares with the results of the survey. If your firm is performing unfavourably in any particular areas take steps to rectify those failings.

If you do, your firm will be much better run and much more profitable.