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Brett Davidson: How to truly measure profits at your firm

Identifying the management information that matters is a key factor in businesses making a profit

Most firms can produce loads of so-called management information, but in my experience what they actually produce is loads of sales numbers. It only becomes MI when it tells you something useful about your business and helps you make better decisions for the future.

This is particularly important if things are not going quite as you would like. If you keep doing what you’ve always done you will keep getting what you’ve always got.

The profitability ratios

When asked what their profit is, most owners I speak to tell me their income; that is, what they have earned from their business. This is not necessarily profit. A business- owner should get paid a fair market rate of income for their day job and then generate a profit on top of that to compensate them for their investment and risk.

It does not matter whether you are structured as a limited liability partnership, a limited company or a sole trader, you need to understand if you are making any genuine profit. Your accountant probably will not produce your financial information in a way that helps you instantly see your real profitability. You will need to do this yourself and it is dead easy.

There are three headline measures to consider:

Direct expenses: This is any money paid to advisers or selling directors within the firm. For example, fee or commission splits for self-employed advisers, or if your advisers are employed, their salary package, including National Insurance and pension contributions plus other fringe benefits or bonuses. If you pay introducers from the fee you earn, this also gets counted as a direct expense. Direct expenses should not exceed 40 per cent of gross turnover for the firm. You will see why in a minute.

Overhead: This is every other business expense (paraplanner wages, administrator wages, rent, telephone, technology costs, printing and stationery, marketing, etc). Anything that is not a direct expense is overhead. Your overhead should not exceed 35 per cent of gross turnover.

Net profit: Whatever is left from your turnover after you take away direct expenses and overhead becomes net profit. If direct expenses are 40 per cent, and overhead is 35 per cent, then that leaves you with a net profit
of 25 per cent, which is what good looks like.

Reading the headlines 

Considering these headline measures tells you a lot about your business:

a) Paying too much to salespeople

If you pay more than 40 per cent to the advisers in your firm, you will struggle to make a 25 per cent net profit. Keeping other overheads to 35 per cent of turnover is no mean feat in itself, so paying too much to salespeople is going to squeeze you on your bottom line.

Making less than 25 per cent net profit puts your personal income and the business at risk when times get tough. In difficult times, the owners often have no choice but to reduce their income to cover the other running costs of the business. This is complete insanity, if you ask me. Also, with rising capital adequacy requirements and seemingly endlessly rising business costs, if you do not  make a genuine profit (after you and everyone else is properly paid for their day jobs) you may start to question why you do not just go and get a job as an adviser for someone else’s firm. In far too many businesses the owner is paid the lowest percentage of the business income they produce.

b.) Are you efficient? 

In a mature business, if your overhead is greater than 35 per cent, 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 hit your 25 per cent net profit benchmark.

It might be different if your business is younger and in the early investment stage of its growth, but do not 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 three to four years of leeway and in year five I would be looking to be close to these ratios.

Management matters 

Identifying the management information that matters is a key part of running a successful business. If you have been in business a long time, but are still feeling like you have not fulfilled your potential, this may be an area that can help you break through.

Brett Davidson is founder of FP Advance

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  1. Sincere thanks for this, Money Marketing for publishing it and Brett Davidson for writing it. This is one of the most practical and realistic articles on the subject I’ve read in a long time. Thank you. (It was also good to know we’ve got our formula right!)

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