What it means
Firms handle client money in many routine situations. A solicitor holds the deposit for a house purchase, an accountant receives a tax refund for a client, and an estate agent collects rent on behalf of a landlord.
The core principle is segregation. Client money sits in a separate bank account, usually labelled as a client or trust account, so that it is protected if the firm gets into difficulty and is not mixed with the firm's own cash.
Record keeping must show, at any moment, how much belongs to each client. The firm keeps a client ledger for every person or matter and checks regularly that the total of those balances matches the money in the bank.
Rules differ by profession and country, and regulators often require annual reports, periodic reconciliations and independent reviews. Because the details vary, a firm should always follow the rules of its own regulator and not copy another sector's practice.
The firm must not use client money for its own purposes, such as paying rent or salaries, even temporarily and even with the intention of repaying it. Any shortfall must be corrected immediately and, where the rules require, reported.
Fees need care. A firm can usually move money from the client account to the office account only to pay a properly issued invoice, and only once the client has agreed or the right to do so is clear.
In practice
Real-world examples
Example 1
A property management company collects $2,400 of monthly rent from a tenant for a landlord. The money goes into the client account and, after the firm's agreed fee of $240 is deducted, $2,160 is paid to the landlord.
Example 2
An accountancy firm receives a $9,000 tax refund for a client. It places the money in the client account, records it on that client's ledger and pays it over within the agreed time. The ledger entry shows the date in and out, so there is a clear audit trail.
Example 3
A financial adviser's firm holds $50,000 awaiting investment for a client. It keeps the money in a segregated account and does not use it for the firm's expenses while waiting for the client's instructions. The client ledger shows the amount, the date received and the date of any later movement.
Think of it
Imagine you give a dry cleaner twenty pounds to hold while they clean your coat. That money is still yours while they hold it, and they keep it in a separate cash box from the shop earnings until you collect the coat.
Formula
Calculation
Adjusted bank balance = Bank statement balance + Deposits in transit - Uncleared payments
Reconciliation test: Adjusted bank balance must equal the total of client ledger balances
A law firm's client account statement shows $182,000. There are deposits in transit of $1,500 and uncleared payments of $4,000, so the adjusted balance = $182,000 + $1,500 - $4,000 = $179,500. The client ledgers add up to $178,500, so there is a difference of $1,000 that must be investigated. It could be a fee moved to the office account too early, or an unrecorded bank charge, and it must be corrected promptly.Case study
Seen in the real world
Calderbank Legal is an illustrative, fictional two-partner law firm that handled property sales. During a busy month the office account ran low just before payroll, and a partner moved $12,000 from the client account to cover wages, planning to put it back the following week.
The monthly reconciliation exposed the gap. Because the client ledger total exceeded the adjusted bank balance by $12,000, the second partner had to report the shortfall to the regulator, repay it from personal funds and accept a formal warning.
In this illustrative story the firm introduced a rule that only one person could authorise client account transfers, with a second person reviewing each month. It also set up a small overdraft on the office account, so cash flow pressure would never again tempt anyone to borrow from client funds. A monthly report to both partners now shows the reconciliation result.
Watch out
Common mistakes
- Using client money as short-term working capital for the firm, even with the intention of repaying it.
- Leaving the firm's own money in the client account, which can blur ownership and breach the rules.
- Failing to reconcile the client account regularly, so that errors are discovered months late.
Questions
People also ask
Does client money earn interest?
That depends on the rules and the agreement with the client, since some regimes require interest to be paid to the client when the sum is large or held for a long time.
What happens to client money if the firm fails?
Properly segregated client money is held for the clients and is generally protected from the firm's creditors, which is why the segregation rules matter.
Is a client's prepayment for work client money?
It depends on the terms and the profession, and a payment for work not yet done is often treated as client money until the firm has earned the fee.