Like many advisors, one of my clients kept his financial records in what I call "the glorified checkbook" system: he wrote down the money that came in, the amount he paid out, and if anything was left in the checking account at the end of the month, that was great. For years, I tried to get him to move to a more detailed accounting system, but he didn't want to take the time or make the effort that such a change would require, and kept putting me off with the old "if it ain't broke, don't fix it" rationale.
Finally, at the beginning of this summer he agreed to make the leap; buying QuickBooks online accounting software and having all his 2008 transactions entered into it. The transition was going swimmingly until he discovered his administrative assistant had been charging personal items on the company credit card--over $15,000 worth this year, alone. Before now, all my client had ever looked at was the monthly balance on the card and signed the check to cover it.
I'm sure I don't need to point out the irony in the fact that a significant number of financial advisors don't keep adequate financials. The old check book system lacks the checks and balances necessary to ensure that you're not over-charged by your vendors, underpaid by your clients or broker/dealer, or in the worst case, the victim of financial fraud. What's more, it doesn't give you the financial information you need to make successful decisions about where to direct your resources to grow your practice, or maximize your income. In fact, I believe that inadequate accounting is probably the leading cause of stagnating advisory practices today. The real irony is that good bookkeeping isn't rocket science--and once in place, it's actually easier than the patchwork "system" you're probably currently using.
More Is Sometimes Less
Now, before you write me off as na??ve, rest assured I do understand the issue of small business taxes--that the goal of most small businesses (and all independent advisory firms fall into the category of small businesses) is to take as much money as possible out of the business as deductable expenses, leaving as little profit as possible. While there's no data on this, I believe most advisors use the checkbook accounting system in the mistaken belief that these vague records will make it harder for the IRS or state tax auditors to determine whether your deductions are legitimate or actually personal expenses in disguise.
Here's a news flash for you: They don't have to determine if your deductions are legitimate or not, the law says that's your job. And worse, there's no bigger red flag for an auditor than confused bookkeeping, especially in a financial business. The reality is that the best defense to an IRS challenge is clear, accurate books that spell out where every revenue penny came from, and what every expense penny paid for. When auditors have nothing to question or disagree with, they tend to lose interest. Plus, without adequate bookkeeping, you can't do tax planning--you may not want to increase your quarterly tax deposits, but if you're making a lot more money this year than last, you might want to put some of it away to pay those additional taxes at the end of the year.
In addition to a much sounder tax footing, good financials make it easier to run your practice, and your life, in myriad ways. For instance, I've observed that a recurring pattern for many financial advisors occurs when their practice revenues begin to grow substantially, which often happens when revenues hit the $250,000 to $500,000 range. With a more successful firm, advisors often feel that they can finally start to improve their--and their family's--lifestyle: An "I'm making more, so I can spend more" mentality.
What they don't realize, particularly if they don't have good financial data, is that the firm's expenses are usually rising, too. In fact, expenses at many firms in this range will actually be growing faster than revenues, which means that the advisors will be taking home less, not more money. Then to fund the shortfall that their premature lifestyle bump created, they take on more personal debt, that will take years to payoff, and create increased pressure to grow their firm even more.
Good financials, of course, would have revealed this expense trend in its early stages, heading off the belief that successful practices are paying advisors more than they actually do. By benchmarking current revenues, expenses, cash position, and owner's income against their historic levels, advisors can take the pulse of their practice at a glance, and make better assessments of where the business and their income is headed, and what, if anything, to do about it.
Good data will also help to avoid making the next mistake along the traditional learning curve--projecting unrealistic expectations to grow practice revenues in an effort to outpace an advisors' growing personal revenue. I can't tell you how many times I've seen advisors anticipate 35% annual growth, when their firm has never done better than 10% or 15% in its best years. That's not to say those firms can't reach 35% growth, but to get there, their owners will have to do some things very differently than they have in the past.
The third stop on the advisory growth curve usually occurs when revenues top $500,000, and advisors decide it's time to show the world they've finally "made it." Bigger offices in more chic locations, nicer furniture, more sophisticated technology, more staff, and lavish "client appreciation" events are typical elements in advisory coming out parties. But here too, the discipline of reviewing financial trends every month can help mitigate damaging decisions. All large expenditures and increases in overhead are automatically cast in the light of their effect on the firm's expense margins. Those with little potential to increase revenues--which usually includes all of the above--are regularly discarded as bad investments of the firm's resources.
Good financial data also empowers advisors to make larger, strategic decisions about how best to grow their firm, what client segments to target, and whether their B/D is worth the cost vs. the RIA custodian option. I've noticed that most registered reps don't have a clue what their B/D relationship actually costs, with various payouts on different products, trading costs, staffing to interface with the B/D, and fees for various services deducted from their payouts. (We've been trying to quantify these costs for one of my clients for over six months; the B/D doesn't seem to be in a hurry to provide all the info to help us sort it out.)
Once your business strategy is set, and your personal finances have a plan of their own, the next step is to get accounting systems, chart of accounts, and a trustworthy bookkeeper that will generate the data you need to run your firm. I recommend that my clients use QuickBooks Online because it's more than powerful enough for a small business, yet very user friendly. The goal at a minimum is to track your current and historical revenues, accounts receivable, accounts payable, and all your expenses, including each item you charge on your business credit card(s) (not just a "credit card" expense).
The idea is to create checks and balances to monitor each of these areas: are revenues going up or down, and is there any change in where they are coming from?; do your receivables from your B/D or custodian match your calculations of what they should be (don't just assume they are right)?; are you paying your creditors too late or too soon?; and are your expenses legitimate (an old Arabic proverb tells us to trust in Allah, but tie up your camel) and in line with your plan for reinvestment or cash flow?
Finally, all these figures and ratios can be pulled together in a profit and loss statement and compared to previous periods. That way, you can see at a glance where your business is headed, and whether things are in line with your expectations and your plans for the future. Without these minimum financials, you're really just flying blind, with no basis upon which to make sound decisions, or to evaluate the success or failure of the decisions you have made, or to monitor whether you're getting paid, and paying, what you're due. The bottom line is that to grow the firm you want, you have to know where it's going before it gets there.
Angela Herbers is a virtual business manager and consultant for independent financial planning firms. She can be reached at email@example.com.