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Profit Is Not a Four-Letter Word

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Most if not all owners of independent advisory firms focus on growing their businesses. Generally, that is a good thing: growth is usually a sign of a healthy business.

However, (you knew there would be a however) because most owners of independent firms have little or no formal business training, there’s a lot of confusion about just what “growth” is, and how it’s measured.

Rhe current trend among larger advisory firms is to reach $1 billion in client AUM. That’s a worthy goal, if it’s accompanied by reaching some other goals at the same time.

For instance, many firm owners who have set their sights on high AUM or revenue goals (which basically are the same thing), have been disappointed when they attain said goal. Usually, that’s because they find themselves making the same or even less money than when their business was smaller.

The takeaway here is that profits— not revenues — are the measure of a healthy business. I know that many of you baby boom firm owners (who still wear tie-dyed T-shirts under your white shirts) believe that profits are the devil’s instrument.

But, as any second-year B-School student can tell you, if the profitability of your business isn’t growing, there’s something wrong. 

Here’s what I tell my clients to help them refocus on the bottom line:

Don’t think about profits as how much you make. Contrary to what some firm owners believe, you don’t have to take home all your firm’s profits.

Instead, you can reinvest some, or even all your annual profits back into your business to help it grow. New and/or better marketing, technology, and training are typical improvements, as are new employees and branch offices.

Profitability is a measure of efficiency. Rather than thinking about profits as ill-gotten booty, see them for what they are: a comparison of the cost of your services with how much people paid for them.

As a business owner, it’s one of your primary jobs to continually look for better, cheaper, and faster ways to deliver your ‘product” — which in your case is financial advice. Your report card is the profitability of your business.

If your revenues are growing, but your profitability is flat or even falling, you’re not doing your job. At the very least, profitability should hold flat as your revenues grow. But if you’re doing your job — and scaling your business —profitability will increase.

Ignore industry studies. As far as I can tell, every owner advisor in the industry wants to know what the average profit ratio is for firms of their size.

If you take anything away from this article, let it be this: Stop worrying about industry averages. They are aggregates of data that may or may not apply to your business.

Don’t set “target” profit margins. Industry “averages” encourage owners to set “target” profit margins. Setting a fixed profit margin, say 20% of revenues, is simply a way of avoiding doing your job as an owner.

Instead, focus on two things: 1) Is your business sufficiently profitable that it supports the goal of you and the other shareholders? And, 2) Is your profit margin growing at the same rate or faster than your business is growing?

Pay particular attention to compensation structures. In my experience, in their commendable attempts to share their business’s success with their employees, many firm owners create incentive plans that eat up profits from new business.

Through bonuses, sales commissions, and/or revenue sharing formulas, owners can greatly increase their revenues, while at the same time, severely erode their profit margins.

Don’t get me wrong. I’m a big advocate of firm owners creating strong financial incentives for employees to help grow their firms, particularly incentives on revenue. But they must be careful not to give away the store, especially on compensation that is distributed over time.

To see the effects of comp plans spread over a long period of time, I use stress tests. That is, we create spreadsheets showing the projected revenues out 10 years or so, for different types of new business, and then factor in the effects of a comp plan over that period. In many cases, we find that what seems like a reasonable compensation will effectively wipe out the profits from the new business it’s based on.

Profits are the vital statistics of your business. And the direction they are heading is a measure of how well your business is running; and how well you are running it. Growing your business is good. Growing your profit margin is great. The more you do both, the more people you can help. 


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