You can read part 1 of this article here.
Profitability ratios
Profitability is an area that firms seem to struggle with. When asked what their profit is most owners I speak to can’t tell me and will defer to or blame their accountant who is often simply trying to reduce the stated profit for tax purposes.
Even worse, firms who operate via an LLP structure will say because they are a partnership they don’t actually work with the concept of profit.
In my opinion regardless of the business structure you operate you should be able to define and measure profitability in your business. How else will you work out if you are doing well, poorly or otherwise?
Three headline measures to consider are these:
- Direct expenses: these are the costs of making a sale or providing advice (whichever terminology you prefer). All costs associated with sales people in your business are recorded here. For example, fee or commission splits paid to advisers, or if they are on wages and salary then this plus NI and pension contributions and any other fringe benefits or bonuses. If you pay away to introducers from the fee or commission earned this also gets counted as a direct expense.
Direct expenses shouldn’t exceed 40% of gross turnover for the firm. You will see why in a minute. - Other Overhead: all other business expenses (paraplanner wages, administrator wages, rent, telephone etc etc). Other overhead shouldn’t exceed 35% of gross turnover.
- Net Profit: Whatever is left after all of that becomes net profit. If direct expenses are 40%, other overhead is 35% then net profit is 25%.
By considering these headline measures in the first instance (before you drill down into the ratios) you can glean a lot about your business.
For example, if you pay more than 40% away to the advisers in your firm, you will struggle to make a 25% net profit. Making less than 25% net profit puts your personal income and the business at risk.
Most firms don’t achieve this benchmark level of profit and the owners reduce their income to cover the other running costs of the business – complete insanity if you ask me. Also, with rising capital adequacy requirements and seemingly endlessly rising business costs, if you don’t make a genuine profit (after you and everyone else is properly paid for their effort) you may start to question why you don’t just go and get a job as an adviser for someone elses’ firm.
In a mature business, if your other overhead is greater than 35% you can instantly glean that you have an inefficient back office. You may not know why this is the case and what to do about it, but you can rest assured it is inefficient. If this area of expenditure is too high you will also struggle to make a 25% net profit.
It might be different if your business is younger and in the early investment stage of its growth, but don’t hide behind this for too long. Typically, firms that struggle with managing the cost vs. profit equation early in their development are still doing it years later, so be careful. If you are new I would give yourself 3 years of leeway and in year 3 I would be looking to be close to these ratios.
Conclusion
Identifying the management information that matters is a key part of running a successful business, rather than a sales organisation. If you have been in business a long time but are still feeling like you haven’t fulfilled your potential then this may be an area that can help you break through.
Bright Talk Webinar
I conducted an in-depth webinar on “Management Information That Matters” on Monday 16th July on Bright Talk. You can still pick up the recorded version here.
