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July 01, 2009 at 04:00 AM
Advisors without a healthy practice and mindset of their own run the risk of being too distressed or distracted to consistently make good decisions–for the firm and for their clients. After so many months focusing on restoring clients’ peace of mind, now is the time for advisors to attend to their own financial health. The business often represents the biggest source of income and value for advisors, so a proper diagnosis should be the first step.
To accomplish this, measure your practice against reasonable standards. While the updated results from past benchmarking studies should be interesting if not helpful, managers of advisory firms must act with even greater urgency to address business challenges they independently face, regardless of what the rest of the industry is doing.
So set some benchmarks of your own by looking at your best year or at historical averages. For example, if your gross profit margin has typically been in the 55% range (gross profit ? total revenues = gross profit margin), analyze how you can get to this same level of profitability based on your current run rate. It is often helpful to translate the negative variance into dollars so that you can judge the magnitude of the problem. Let’s assume your current revenues are $1 million, and your gross profit margin is 50%. That would be a negative variance of 5%. Multiplied by the $1 million revenue, the negative variance equals a $50,000 shortfall from your benchmark target. So what can you do in your business to restore $50,000 of gross profit?
Other key ratios to calculate include operating profit margin (operating profit ? total revenue), revenue per staff, revenue per professional staff, revenue per client, and client per staff.
Isolating the Problem
It may be small consolation that virtually every advisory firm is experiencing lower profitability than they had in the last two years. The freefall in portfolio values alone caused the greatest decline, though other factors contributed to lower margins. From a management standpoint, isolate the costs and profits among Direct and Overhead Expenses, Gross Profit and Operating Profit, so that you can focus your remediation on the right problems.
Gross Profit is the amount left over after fair market compensation to the professional staff, including owners (what it would take to replace you with someone of comparable credentials, experience, and client responsibility). Operating Profit is what remains after Overhead Expenses are deducted from the Gross Profit. Overhead includes such things as administrative staff compensation, marketing costs, rent, utilities, technology, and benefits.
Compare these numbers over a period of three to five years to observe any trends. Isolated numbers provide a snapshot of where you are, but not much insight into what is happening and why. One of the biggest errors that managers make is to regard the firm’s performance against benchmarks as a score–meaning you’re better or worse than your peers–rather than using benchmarking as a tool for gaining insight into your business.
Follow a linear process for translating your finding into management actions:
1) observe the actual numbers compared to a previous period
2) convert the numbers into ratios or Key Performance Indicators
3) examine the ratio trends over a series of periods
4) compare the ratios to a benchmark, whether developed individually or by using industry standards and
5) calculate the financial impact of any negative variance.
