Believe it or not, many companies fail just as they are poised to take off. The requirements of business growth present significant obstacles for unprepared firms. The most common pitfall appears when business growth outpaces the company’s reasonable ability to support it.
This concept finds easy illustration in balance-sheet-heavy businesses such as manufacturing or distribution. These models add inventory and accounts receivable (current assets) in anticipation of or as a result of increasing sales. It’s also quite common for expanding companies to add additional assets like real estate, leasehold improvements, technology, or equipment and furniture. In order to pay for this growing balance sheet, the company’s debt and equity must remain in balance. The goal in managing liquidity is to ensure that liabilities do not grow faster than equity. Financial managers in these types of businesses monitor two important indicators:
The current ratio (current assets ÷ current liabilities), which measures liquidity, or their ability to pay their bills
The debt/equity ratio (total liabilities ÷ equity), which measures risk, or their ability to withstand adversity
A declining current ratio may mean the business does not have enough liquid assets to convert to cash in order to pay off obligations due in a one-year period. A rise in the debt/equity ratio may indicate that the business is not retaining enough profits to increase equity, meaning they must borrow more to fund the increase in assets. Both ratios help reveal if a firm is adding assets too fast or, in financial management terms, not turning over current assets fast enough.
When observed over periods of months and years, and compared to relevant benchmarks, these ratios provide early warning signs. This insight allows you to make adjustments to your business by raising prices, reducing expenses, increasing the pace of collecting receivables, slowing inventory purchases or even selling inventory at a discount to get it off the balance sheet.
Financial advisory firms may not seem balance-sheet-heavy in the traditional sense, though fee collection can be regarded as an accounts receivable or pre-paid asset. Unfortunately, this means that owners may overlook the potential strain on the firm’s financial health until it’s too late. Advisory firms have other “asset” and “liability” growth problems as well, in the form of people whose compensation and related expenses also need to be funded out of current cash flow.
These cash flow requirements cause owners to pause before adding staff of any kind. If they add another advisor without enough clients, how will they pay for her? If they take on non-client-facing support staff, will they be able to cover these added costs and still take home a decent paycheck for themselves? If they hire a general manager or COO to run the business more efficiently, will this free them up enough to bring in clients, and will these clients cover the expense of professional management and also produce a return on investment?
Not adding staff has a price, however. If owners take on more clients than they can adequately support, what will happen to the client experience and the firm’s reputation? Will clients wish to stay with the firm, let alone recommend it to others? What about the risk of error? Or the damage from compliance oversights?
These are all good questions. If you are trying to grow your advisory firm, it’s important to understand one absolute truth: The lack of physical capacity is the single biggest inhibitor to growth.
This argument surprises many who believe that the key to success is attracting new clients. While business development is important, the advisory profession for the most part is not suffering from a dry spell in revenue growth. Rather it is strained by the weight of more clients, more demand for attention and more opportunities to expand into new markets.
How does a firm gauge its capacity for healthy growth? Keep an eye on these key ratios:
Clients per advisor
Clients per total staff
Revenue per client
Revenue per staff
Operating profit per staff
These revealing ratios are great leading indicators of business success and failure.
For example, according to the 2015 InvestmentNews Advisor Compensation & Staffing Study sponsored by Pershing, the top performing ensemble firms had 83 clients per professional staff and 43 clients per total staff. By comparison, the average ensemble firm had 53 clients per advisor and 29 clients per total staff. Let’s assume for simplicity that your average client pays your firm $10,000 a year. Using this example, the 30-client difference in advisors per professional staff (83 – 53 = 30) represents a financial impact of $300,000 per advisor! Multiply that factor by the number of advisors in your firm and you see the magnitude of the problem.
Technology has increased the capacity of advisors to serve more clients, and enhanced the client experience by automating many labor-intensive processes. CRMs, rebalancing tools, reporting software and managed account platforms have taken the heavy lifting out of process-oriented functions within an advisory firm. Assuming you have leveraged applications provided by your custodian or broker-dealer, or outsourced technology to other providers, the challenge becomes how to increase capacity in order to grow revenues and profits.
Advisors at the helm must decide between the three largest levers within their reach:
Eliminate sub-optimal clients so that current staff can focus on the best relationships and opportunities.
Redefine (lower) the client service experience so that your team can service more relationships.
Increase staff through recruiting, merger or acquisition.
Advisors find terminating client relationships the least palatable option. They have worked hard to attract the business and, in many cases, the lowest-value relationships are the oldest and most loyal ones. If certain clients are sucking up resources and not carrying their weight financially, however, it may be best to refer them to other advisors who can give them better attention.
Advisors also find the idea of changing the client experience unappealing. Ironically, if they do not have the infrastructure to serve clients in the manner to which they’ve become accustomed, the experience has been compromised by default. Some advisors decide to segment their client base according to their value to the firm, though it can be difficult to maintain discipline around these service guidelines.
Typically, advisors opt to add staff — and most firms don’t make this decision until they are well over capacity. This presents a whole different set of struggles, including the fact that it takes 12 to 18 months for a new employee to become proficient. Meanwhile, the firm continues to suffer the same stresses. Ideally, advisors should hire when they are at about 80% of capacity, leaving enough time to train and inculcate new hires into the firm culture.
The art of management requires a skillful balance of producing a profit with building a sustainable business. Advisory firms on a growth trajectory have exciting opportunities — and corresponding challenges. Assess your business, pace yourself and make sure you don’t outrun your ability to support new growth. A healthy outcome depends on your logical approach to the goal.
— Read more from Mark Tibergien on growing a firm in “Should You Pay for Referrals?“