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Many financial planning firms collect reams of management information they rarely understand and never use. In this post I introduce three business metrics that will help you to make sense of your data and improve your business performance.
I have seen so many advisers struggle to make sense of their MI, yet by using these three ratios it is possible to reveal and rectify the issues that are holding back your business.
Turning Information into Insight
Answer the following three questions:
What sort of management information (MI) do you collect about your business?
How often and how seriously do you analyse it (as opposed to just look at it)?
What insight does each piece of information provide about your business?
In my experience most firms collect loads of MI, some firms actually analyse it and very few use it to provide insight into what is happening within their business.
As a starting point there are three critical ratios that you have to understand if you are going to manage your business for better performance and profitability:
Gross Profit Margin
Overhead
Net Profit Margin
Ideally direct expenses (which are the expenses you pay away from your top line revenue to salespeople or introducers) should not exceed 40%. All other overheads should not exceed 35%, which leaves 25% as a genuine net profit margin.
Let’s look at each business ratio in turn:
Gross Profit Margin
This ratio is critical as without a suitable level of gross profit margin you have no chance of ending up with any net profit.
Turnover – Direct Expenses* = Gross Profit
*Direct expenses (or cost of sales) is all remuneration paid to advisers and directors that sell to clients (commissions and salary + NI, car allowances, bonuses, directors drawings etc.). It would also include any pay-aways to introducers if you make them.
If you can simply tweak the existing roles of your team and get them working to their strengths (anything they love and are good at) you will be amazed what can be unleashed in terms of productivity, staff satisfaction and client satisfaction.
The money paid to sales people, selling directors and introducers/referrers is paid from gross revenue. It is only from what is left after these payments that the business can pay its other overheads (rent, wages for all other staff, etc.).
When you do this analysis for yourself and look at the three high level ratios you will realise that keeping your business overhead to 35% is no mean feat in itself, so paying away more than 40% of your gross revenues will leave you severely profit squeezed if you are not careful.
In a lot of firms self-employed advisers get paid 50% to 60% of the gross revenue that they bring in. This is unsustainable and is often a contributing factor to poor net profitability.
Gross Profit/ Total Revenue = Gross Profit Margin
For example:
Turnover £500,000
Less direct expenses £200,000
= Gross profit £300,000
Gross profit margin 60% (300,000/500,000)
Overhead
Overhead is all other costs of running your business after direct expenses.
This ratio is also critical as without managing your overhead costs you may also end up with poor net profit levels.
Total Expenses – Direct Expenses = Overhead
Overhead/ Total Revenue = Overhead Percentage
For example:
Turnover £500,000
Less direct expenses £200,000
= Gross profit £300,000
Gross profit margin 60% (300,000/500,000)
Less overhead £175,000
Overhead percentage 35% (175,000/500,000)
Net Profit Margin
Net profit is what is left after direct expenses and overhead are paid. This is the owner’s reward for the risks of running a business (over and above their market salary or drawings which are fair reward for the job they perform within the business).
Good performance within an advisory firm is a 25% net profit margin. High performance firms can even exceed this level of profitability. The vast majority of UK firms don’t hit this basic profitability level after the owners take a fair market salary (i.e. what they could be paid if they took a job down the road with one of their competitors).
Total Revenue – Direct Expenses – Overhead = Net Profit
Net Profit/Total Revenue = Net Profit Margin
For example:
Turnover £500,000
Less direct expenses £200,000
= Gross profit £300,000
Gross profit margin 60% (300,000/500,000)
Less overhead £175,000
Overhead percentage 35% (175,000/500,000)
= Net profit £125,000
Net profit margin 25% (125,000/500,000)
By understanding and analysing these three high level ratios you can identify where to focus your energies if you have a profitability issue. Is it a gross profit margin issue (paying away too much), or is it an efficiency and productivity issue (needing too many people in the back office to process the work).
Just being able to pinpoint the problem can be a giant leap forward and save you weeks, months and even years of wasted time and effort by working on the wrong issue. So go and take a look at these three high level ratios in your own business and see how things are looking. This might be a real eye opener.
Comment I’d love to hear your thoughts on this topic. What are your challenges in this area? How have you resolved some of these issues? Leave a comment in the comments section or drop me an email to brett@fpadvance.com.
Take Action If you want more direct assistance with this or any other aspect of your business drop me a line at brett@fpadvance.com or give me a call on 0207 431 3663.