Last year, an advisor I know made a commitment to convert his insurance-oriented financial planning business to fee-based asset management, and he decided to do it by going “cold turkey.” He’d been prepared for his income to drop–a little, anyway. But in April of this year, he found that his income had dropped from $150,000 in 2000 to only $40,000 in 2001. Ouch!
I asked him why he hadn’t changed course during 2001 when he realized he was having such a bad year. He said, “I was generating a lot of activity, and everything seemed to be going well. I didn’t know how much money I actually made until my CPA prepared my taxes in April.”
Surprisingly, this advisor is not unique. Most advisors work hard, pay all their bills, and take whatever is left over as their personal income. But smart financial management is critical for success–and that means that you need to know where you are, where you want to be, what changes you need to make to get back on track.
Three Levels of Financial Record-Keeping
There are at least three different levels of financial record-keeping. Each one provides a different level of usefulness.
The first is the Shoebox Level, in which you only dig your records out of their shoebox in April when your accountant needs them for tax purposes. At this level, financial information is used to fulfill compliance requirements, and your motivation is simply to stay out of jail.
The second level is the Quicken or Quick Books level, in which financial information can be used to track your business results. In this model, you set up a chart of accounts and allocate your business transactions in accordance with generally accepted accounting principles. This is the level of record-keeping that would have alerted the advisor mentioned above that he should have changed course to keep his net income up.
A third level is the Excel spreadsheet level, in which financial information is used to plan, forecast, allocate resources, develop long-term strategy, and attract capital. This level of information will empower you to envision and create your ideal business.
Don’t Call It a Budget, Call It a “Profit Plan”
At my company, we don’t call a budget a budget, we call it a “profit plan.” These documents are actually the same thing, but one title is perceived as negative and the other as positive.
A profit plan is composed of four primary categories, your Gross Revenue, your Cost of Goods Sold, your General and Administrative Expenses, and your Net Income or Profit. You need to create a detailed month-by-month profit plan every year. Work with your accountant or bookkeeper to develop your company’s profit plan. Each month we print out our projected income statement and compare it to our actual income, and we track our results versus projections on a year-to-date basis.
Under Gross Revenue, you need to create a number of different accounts for each different type of income you earn. This allows you to quickly see where your money is coming from. Typical categories are fee-based revenue, commission-based revenue, split commissions, income from planning, and miscellaneous.
As a service business, you will probably not have many entries under Cost of Goods Sold. This could include management fees and other costs directly tied to generating revenue. Most accountants recommend that all marketing costs are listed under this category. If you subtract Cost of Goods Sold from your Gross Revenue, you’ll get Gross Profit. From your Gross Profit, you need to deduct all of your General and Administrative Costs like rent, employees, office supplies, phone bills, etc.
It is critical to list your monthly income as a line item expense in your profit plan. You can put your income under the General and Administrative Expenses, or you can put it in its own separate category.