In the first part of our post, we discussed the many reasons (beyond the obvious) why profitability is crucial to a firm’s success. In the second part of our post, we’ll discuss the role of profit margins in business stability.
For many planners, a potential business sale may still be many years or even decades away (even for “older” veteran planners who may decide they’d rather keep their business as a lifestyle practice rather than sell it). As a result, short of a buy-sell arrangement to be executed in the event of death or disability, the idea of profit margins as it impacts business valuation is often simply not on the radar screen. However, the reality is that the profit margins of a financial advisory firm are crucial for another reason, too: the stability of the business for its staff and clients.
The reason that profit margins matter in this context is that, unfortunately, the revenue and expenses of a business are not stable; one or both change over time. For instance, in the 2008-2009 financial crisis, the precipitous market decline led to a precipitous revenue decline for firms that were priced directly on assets-under-management (AUM) or indirectly through mutual fund or annuity trails.
If the firm had a 25% profit margin and experienced a 25% decline in revenue due to the market, the owners may not have enjoyed any profit distributions out of the business that year, but there was still room for them to earn their salaries and keep the firm steady. By contrast, a firm that only had 10% profit margins suddenly found itself deeply in the red, forcing the business owners to either plow significant dollars back into the business, or start cutting expenses—which for most planners, usually means firing staff, since professional and administrative staff are the overwhelming majority of all expenses in an advisory firm. In other words, the size of the firm’s profit margin is the size of the firm’s cushion to deal with the uncertainties of business without needing to downsize.