Information is power
If you’ve been working on the first five areas to get you moving forward: culture and values, people, process, business management, and client profile, then there’s just one last area to focus on. Your financials.
Most firms can produce loads of so called management information (MI), but in my experience what they actually produce is loads of sales numbers. It only becomes MI when it tells you something useful about your business, and helps you make better decisions for the future.
This is particularly important if things are not going quite as you would like.
If you keep doing what you’ve always done you will keep getting what you’ve always got.
Rounding up your ratios
One way of obtaining greater insight from the numbers is to convert your financial information into ratios.
These ratios allow you to examine various aspects of your business, compare your firm with other firms (regardless of size), and see if actions taken are translating into better business performance. Top-line revenue growth tells you none of this, and yet this is what most people quote when asked if their business is going well.
This topic is covered very well in Mark Tibergien and Rebecca Pomering’s book, Practice Made More Perfect and I am using the ratios they describe there:
- Profitability ratios
- Productivity ratios
- Client selection ratios
The Profitability Ratios
Profitability is an area that firms seem to struggle with. When asked what their profit is, most owners I speak to can’t tell me and will defer to or blame their accountant, who is often simply trying to reduce the stated profit for tax purposes.
Even worse, firms who operate via an LLP structure will say because they are a partnership they don’t actually work with the concept of profit.
In my opinion regardless of the business structure you operate you should be able to define and measure profitability in your business. How else will you work out if you are doing well, poorly or otherwise?
There are three headline measures to consider:
1. Direct expenses: These are the costs of making a sale or providing advice (whichever terminology you prefer). All costs associated with sales people in your business are recorded here. For example, fee or commission splits paid to advisers or, if they are on wages and salary, their salary package including National Insurance and pension contributions plus any other fringe benefits or bonuses. If you pay away, to introducers from the fee or commission earned, this also gets counted as a direct expense.
Direct expenses shouldn’t exceed 40% of gross turnover for the firm. You will see why in a minute.
2. Other Overhead: Which is all other business expenses (paraplanner wages, administrator wages, rent, telephone, technology costs, printing and stationery, marketing etc). Other overhead shouldn’t exceed 35% of gross turnover.
3. Net Profit: Whatever is left after all of that becomes net profit. If direct expenses are 40%, and other overhead is 35%, then that leaves a net profit of 25%.
Reading the headlines
By considering these headline measures in the first instance you can glean a lot about your business.
For example, if you pay more than 40% away to the advisers in your firm, you will struggle to make a 25% net profit. Keeping other overhead to 35% of turnover is no mean feat in itself, so paying away too much to salespeople is going to squeeze you on your bottom line.
Making less than 25% net profit puts your personal income and the business at risk when times get tough.
Most firms don’t achieve this benchmark level of profit and in difficult times the owners often have no choice but to reduce their income to cover the other running costs of the business. This is complete insanity if you ask me. Also, with rising capital adequacy requirements and seemingly endlessly rising business costs, if you don’t make a genuine profit (after you and everyone else is properly paid for their day jobs) you may start to question why you don’t just go and get a job as an adviser for someone else’s’ firm.
In a mature business, if your other overhead is greater than 35% you can instantly glean that you have an inefficient back office. You may not know why this is the case and what to do about it, but you can rest assured it is inefficient. If this area of expenditure is too high you will also struggle to hit your 25% net profit benchmark.
It might be different if your business is younger and in the early investment stage of its growth, but don’t hide behind this for too long. Typically, firms that struggle with managing the cost vs. profit equation early in their development are still doing it years later, so be careful. If you are new I would give yourself three to four years of leeway and in year four I would be looking to be close to these ratios.
The Productivity Ratios
If we look at some of the productivity ratios they include:
- Revenue per adviser
- Revenue per staff
- Clients per adviser
- Clients per staff
- Net profit per adviser
- Net profit per staff
You can probably see for yourself that analysing these aspects of your business will give you tremendous insight into how productive your business really is. For example, if you have a clients per staff ratio (i.e. Total Clients divided by No. of Total Staff) of 27, and the firm down the road has a ratio of 39, there might be some lessons you could learn from them about how they have structured their business processes.
Obviously, all of these ratios need to be looked at in context with each other, rather than in isolation, but they start to shine light on the areas of your business that could be improved.
The productivity ratios in particular are often neglected completely by firms, and this shows up as poor profitability and a difficult working environment (for you, your staff, or both).
Most adviser-owners are front office, client-facing types who don’t have strong skills in designing better business processes. However, without a focus on this area you will struggle to break through and achieve your potential.
The Client Selection Ratios
These ratios include:
- Revenue per client
- Gross profit per client
- Net profit per client
- AUM per client
- Average recurring income per client
Improving client selection over time is the third lever you can lean on to improve profitability. As I discussed in Moving Forward: Client Profile, improving client quality is a powerful way to boost adviser productivity and business profitability.
By tracking the various ratios quarter by quarter and year by year, you can see the impact of the choices and decisions you have made.
These ratios allow you to track progress, even if there are major changes to your business, such as a new acquisition, or a major re-structuring or downsizing. If you are not careful, these major changes to your business can hide a multitude of sins.
Growth by acquisition strategies in particular can allow the group to believe they are growing and performing better, when in fact underlying performance might be deteriorating. Using the ratios can help you see through all of this.
In fact, if you are contemplating an acquisition or disposal you can even model the likely impact on your financial ratios before you proceed. Just to be sure that the right trends are likely to show up post transaction.
Identifying the management information that matters is a key part of running a successful business, rather than a sales organisation. If you have been in business a long time but are still feeling like you haven’t fulfilled your potential then this may be an area that can help you break through.
Just in case you missed them, you can catch the first five articles in my Moving Forward series here: Part 1 on Culture and Values, and Part 2 on People, Part 3 on Process, and Part 4 on Business Management, Part 5 on Client Profile.
There are six areas that you need to master if you want your business to really move forward:
Give yourself a score out of ten for each of the following statements. The higher your total score the closer you’ll be to the perfect financial management for growing your business:
- The three key business ratios are collected and reviewed at least quarterly (Profitability Ratios, Productivity Ratios and Client Selection Ratios)
- All owners/directors know and understand key aspects of the Profitability Ratios (i.e. Direct Expenses, Gross Profit, Total Overhead and Net Profit)
- The business receives regular monthly financial reporting and knows where it is in relation to turnover and profitability targets
- All owners/directors are paid a fair market rate for their day to day work within the business
- Direct Expenses don’t exceed 40% of turnover
- Total Overhead is not more than 35% of turnover
- The business generates a net profit of 25% or more of turnover (after everyone gets paid a fair market rate for their day-to-day roles)
- The owners/directors understand what drives net profitability within the business
- All team members are regularly briefed on the need for a commercial return on the business’ activities and understand their role in delivering it
- Any incentive schemes reward the whole team for excellent performance (recognising that it takes a team to deliver it)