10 Financial Red Flags Lawyers Should Never Ignore

If you’ve ever had a quiet thought of, “I hope no one ever really looks under the hood of these books,” this one’s for you.

At The Proper Trust, we spend our days (and more late nights than we’ll admit) inside law firm financials. We see the same patterns over and over, especially with firms who suspect something is off but can’t quite name it.

This blog is your financial health check: a tour of the biggest red flags we see in law firm accounting, what they actually mean, and when it’s time to bring in a specialist who lives and breathes legal bookkeeping.

1. Your Trust Account and Your Reports Don’t Match

Let’s start with the one that keeps lawyers up at night.

A quick self-test:

1. Run a Balance Sheet in your accounting software (e.g., QuickBooks Online).

2. Look at your trust bank account balance.

3. Look at your client trust liability total (often stored as “Funds held in trust” with individual client sub-accounts).

Those two numbers should match.

If they don’t, that’s a flashing red light. Common reasons:

• Old matters that were never fully cleared

• Retainers applied incorrectly or twice

• Money moved out of trust in the real world without matching entries in the books

• Practice management software and accounting software drifting out of sync

And if you’re using legal tech like Clio, LeanLaw, PracticePanther, etc., there’s a third number that should match: the balance in your legal software’s trust ledger.

That’s your three-way reconciliation:

Trust bank balance = total trust liability in your books = total trust balance in your legal software.

If those three don’t line up, and you’re not sure why, that’s not “messy bookkeeping.” That’s a compliance problem.

2. Your Chart of Accounts Looks… Creative

Your Chart of Accounts is the backbone of your financial reporting. When it’s well-built, your P&L and Balance Sheet tell a clear, confident story.

Some red flags we see way too often:

• Employee names listed as expense accounts (e.g., “Wages – Mary Smith,” “Wages – John Jones”)

• Vendors listed as separate accounts (“Office Supplies – Staples,” “Office Supplies – Office Depot”)

• Trust activity sitting on the Profit & Loss instead of the Balance Sheet

• Account numbers that stop at 4000 (income) and never continue for expenses or liabilities

What this tells us:

• Your books were built by someone who either didn’t know legal-specific accounting or tried to “DIY” the structure

• Your financials may not inspire confidence with a bank, lender, or potential buyer

• Your tax professional has likely been “massaging” the numbers offline instead of tying them cleanly to your books

You deserve better than financials that make a bank underwriter or bar auditor raise an eyebrow.

3. Advanced Client Costs Are a Mystery Bucket

If your firm advances costs (PI, litigation, immigration, etc.), advanced client costs should be handled carefully and consistently.

Red flags:

• Costs sitting in generic “Billable Expense Income/Billable Expense” accounts

• Large negative balances in specific client cost ledgers

• Settlements arriving with no clear matching of income versus reimbursed costs

• Long lists of ancient unreconciled costs for matters that have already settled

Handled properly, advanced client costs:

• Live on the Balance Sheet (often in an “Advanced Client Costs” asset account)

• Are tracked by matter

• Clear out as settlements are disbursed

This isn’t just a “nice to have.” The IRS has specific expectations for how contingency firms treat advanced costs. If your current books don’t reflect that, it’s worth a second look.

4. Old Uncleared Checks and Deposits

Another easy health check:

Ask to see your bank reconciliation report (not just “yes, it reconciles”).

Red flags:

• Uncleared checks or deposits lingering from years ago

• Deposits you’re sure were received but still showing as “uncleared”

• Trust checks never cashed and never dealt with

On the trust side, this touches compliance:

• Stale checks may need to be voided and handled according to unclaimed property/escheatment rules

• Old uncleared deposits might signal mis-posted or duplicate transactions

If your reconciliation reports look like a time capsule from 2016, it’s time for a cleanup.

5. You’re Paying for Software You Aren’t Really Using

We see this all the time:

• A firm pays for Clio, LeanLaw, or another practice management platform

• Trust activity and bills are partly entered there - but not consistently

• Spreadsheets, sticky notes, and “mental math” fill the gaps

Or:

• Payments platforms (Confido, Gravity, etc.) are set up

• Money flows into the bank days after the legal software shows it as received

• No one is tracking the timing, so trust appears “in balance” in one system and off in another

Red flags here:

• “We use the software… sort of.”

• Bills aren’t actually being generated from the system, just “payments”

• No clear mapping from software → trust ledger → operating account

If you’re paying for legal software, it should be serving you. By creating clean ledgers, usable reports, and defensible trust records. If it’s just a fancy interface on top of confusion, something’s wrong.

6. Books and Tax Returns Don’t Tie Together

One of the biggest structural red flags we see:

The firm’s bookkeeping has never been tied to the tax return.

Signs this might be you:

• Your tax professional “does their thing” each year but never walks you through how the return ties to your P&L and Balance Sheet

• There are big, unexplained differences between what your books show and what your return reports as income or expense

• Nobody can clearly answer, “Do our financials match what’s been filed with the IRS?”

In a healthy setup:

• The year-end trial balance supports the tax return

• Adjustments are documented

• You can confidently hand your financials to a lender, investor, or potential partner knowing they tell the same story as your filed returns

If no one has ever reconciled those two worlds, that’s a quiet but serious warning sign.

7. Labor, Productivity, and KPIs That Don’t Add Up

As firms grow, labor becomes one of your biggest investments, and your biggest clues.

Red flags for mid-size and larger firms:

• You have no clear KPIs (key performance indicators) around productivity, realization, or leverage

• Unbilled time keeps creeping up, and no one can say exactly why

• Compensation rises, but you’re not sure whether the related revenue does

• One attorney or team’s unbilled time is consistently out of proportion to their billed and collected work

Healthy firms pay attention to:

• Labor costs as a percentage of revenue (adjusted by practice area)

• Billed vs. collected vs. written off

• Productivity by person, practice area, or office

You don’t need a Wall Street dashboard, but if you can’t see where your time and money are going, it’s very hard to course-correct.

8. Multi-State, Payroll, and 401(k) Complexity… with No Oversight

As soon as your firm has:

• Employees in multiple states

• A 401(k) plan

• Complex payroll, bonuses, or draws

• Remote staff or of-counsel relationships

…your compliance risk goes up.

Red flags:

• 401(k) loan balances that never move or don’t match plan records

• Payroll liability accounts sitting at strange, long-standing balances

• No clear owner for making sure state payroll, unemployment, and withholding are correct

• A paralegal or office manager “doing the books” on top of everything else

None of this means anyone is doing something wrong on purpose. It just means the complexity has outrun the person in the seat.

That’s the moment to bring in someone who understands both law firm structure and accounting.

9. You Have a “Managing Partner” in Name Only

In well-run firms, the managing partner actually manages:

• Understands the firm’s financials

• Knows where HR, benefits, and compliance live

• Partners with external professionals instead of flying blind

A red flag we see in many growing firms:

• The “managing partner” is still 90% in billable work and 10% in management - with no real bandwidth to watch the business of the firm

• No one is truly responsible for the financial health of the practice... just “whoever can squeeze it in”

You don’t need to become a full-time COO. But you do need:

• Clear visibility into the numbers

• Trusted partners who can interpret them

• Enough structure that you’re not running a multi-million dollar firm off of gut alone

10. Your Gut Already Knows Something’s Off

Honestly, this might be the most important red flag of all:

You already suspect your records aren’t right—especially around trust—and it’s bothering you.

We hear variations of this all the time:

• “I know my trust isn’t correct. I just don’t know how bad it is.”

• “I can’t sleep at night thinking there might be something wrong in there.”

• “We’ve grown so much that I don’t know if our systems have kept up.”

That feeling is worth listening to.

You don’t have to know what’s wrong. You just have to be willing to let someone look.

If you’re reading this and mentally checking boxes: trust not quite right, odd chart of accounts, long-ignored advanced costs, or just that gnawing worry... this is the perfect time for a financial health check.

You’ve worked too hard building your firm to let uncertainty run your back office.

Let the numbers tell a clear story. One you can stand behind with confidence.