If a business isn't growing, it's . . . well . . . you fill in the blank. As CEO of your small business, you are responsible for leading a thriving entity. And to thrive, you also need to wear the hat of CFO.
A chief financial officer is responsible for managing a firm's financial risks. Advisors may find it as natural as breathing to review their clients' financial goals, investment performance and risk, but that instinct doesn't necessarily kick in when it comes to tracking their own company's financial health. Some advisors assume that, if they take care of their clients, their firm's finances will take care of themselves. That's a dangerous assumption.
Practice What You Preach
A decade ago, advisors often didn't know what their overhead was. As organizations have grown and merged into larger entities-and margins have continued to shrink-advisors have become more motivated to better manage the finances of their businesses.
Today, our industry is lucky to have an expert to help advisors step into the CFO role, Mark Tibergien. He has written books-the most recent, with Rebecca Pomering, is Practice Made (More) Perfect: Transforming a Financial Advisory Practice into a Business. He has also given presentations at major conferences and generally been a force for motivating advisors to become more sophisticated in managing their fiscal responsibilities. Still, many advisors remain unsophisticated when it comes to using financial data to manage their firms.
What keeps advisors from embracing these resources? There are several ideas:
Change is hard. If an advisor has operated with a seat-of-the-pants approach to financial oversight for decades-or is a baby boomer getting close to retirement-he or she may feel that making a big change is not worth the effort. Would a younger advisor be more willing to embrace the role of CFO?
New technology and software. Becoming fluent in new software requires energy. For example, many advisors use QuickBooks, but resetting and reformatting the software requires time-time to understand the accounting principles of solid fiscal management, time to decide what is reported monthly and time to make the changes. Even if a third party helps keep the books, the advisor must communicate what he or she is looking for. Furthermore, once the data is received, the advisor must know how to interpret it for its use in the firm.
Inertia is powerful. Before advisors look for a more sophisticated way to assess their firms' financial performance, they want to know what's in it for them. Many solo organizations, in particular, don't see a compelling reason to change.
A Growing Divide?
When it comes to sophisticated business management, there seems to be a growing divide between larger firms with multiple advisors and their solo counterparts. They have different perceptions of the value of:
Producing a balance sheet, an income statement and a statement of cash flow monthly.
Paying advisors a defined monthly salary as a direct cost of running the business.
Applying OPM and GPM to analyze the financial performance of the firm.
Calculating and using productivity ratios.
Applying generally accepted accounting principles (GAAP).
Although it may be a best practice to embrace the above, it is a worst practice to make no effort at all to enhance fiscal management. Every organization, regardless of size, benefits from carefully forecasting revenue and tracking expenses.
Forecast Revenue Annually
Some advisors are hesitant to forecast revenue for the next year, and some rely on a casual approach, plucking a number out of thin air. But a more formal approach is to arrive at a forecast based on detailed analysis. Consider the following method:
1. Old/old. Start with recurring revenue from existing clients. What can you safely assume will be generated from existing clients in the next year if the market stays the same? Recurring revenue includes 12b-1 and AUM fees, annuities with commission paid over time or ongoing insurance premiums. All three are examples of recurring "old" revenue from existing clients.
Subtract systematic withdrawals that you are confident will occur. This is especially important for advisors with a book of clients who are predominately in retirement.
Subtract the assets of any clients you are reasonably sure will be leaving you or whom you plan to terminate.
2. Old/new. Add to your calculations any new monies (and their impact on the bottom line) that you are confident you will receive from existing clients. If, for example, you know that Tom Jones will retire in June and roll over $500,000 for your firm to manage, include that. In addition, don't forget to add the total existing periodic investment plans of existing clients.
3. New/new. Add new assets from anticipated new clients. Consider the number of new clients you tend to take on, as well as the amount of your average commission sale and/or the average AUM of your clients.
Add the impact of other factors you are confident will occur. If you have new initiatives scheduled, how will they impact the top line? If you are investing in new marketing campaigns, when do you expect results? On the other hand, if you are converting commission-based clients to fee-based clients, how many clients will this impact and when? A strategic example is the pending purchase of a book of clients. If the buy-sell is signed and the transition will occur in the upcoming year, what will the revenue impact be?
Convert AUM and/or expected commissions to revenue-applying payout structure.
Somewhere between the casual and the formal approach is the application of historical data. For those with decades of experience, applying the percent of average annual growth they have experienced can substitute for the analytical process.
Coming up with a revenue forecast is easy if you pull a number out of thin air. It takes careful analysis to be accurate. And, even then, given all the variables that impact the top line in any given year (and especially market movement for fee-based advisors), many advisors find it useful to project a range of anticipated revenue growth instead.
Create A Written Annual Budget
Below are some common budget items.
Business development or marketing expenses
Health insurance and employee benefits
Outsourcing (excluding IT)
Equipment leases, purchases and maintenance
Aligning budget items with data from a third party sets the firm up for possible benchmarking. The items above were chosen from categories in the biannual Moss Adams Financial Performance Study of Advisory Firms. Even if you don't benchmark externally, consistency of expense categories allows internal benchmarking from one year to another.
Of course, one can look at historical data as a starting point for estimating a budget, but the analysis of a business plan and relevant costs associated with identified goals help ensure greater accuracy of projections. For example, if you plan to rebrand your logo, stationery and Web site, you should include graphic design, printing, Web development and possible external consulting costs.