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Phil Billingham: Turnover is vanity, profit is sanity

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If only life were as simple as the cliché suggests. After all, it is very difficult to create a £100,000 profit from a £50,000 turnover. So turnover is vital to profit but the underlying truth is that profit is king.

That leaves the two key questions for advisory firms: What is our profit? What should our profit be?

We tend to work on the very basic principle that in an owner-managed business, the owner and manager should be paid twice. Once for doing the job they do each day and once for owning the business, risking their capital. The difficulty is often that the tax system rewards “ownership” income (dividends) over “doing the job” income (salary).

As an example, Jane Smith Financial Planning has a turnover of £300,000, with Jane as the planner, two paraplanners and an administrator. Jane is the 100 per cent shareholder. The expenses amount to £180,000, leaving Jane with £120,000 before all taxes. So 40 per cent profitability, right?

Well, no. We would say that Jane has a gross market salary – the cost of replacing her as a planner – of £90,000 (inc NIC, etc). So as a shareholder, she really has a profit margin of 10 per cent.

Which is not to be sneezed at, and is not untypical of good firms, as our recent survey of accredited financial planning firms showed.

But we believe that a 20 per cent profit margin is a realistic target for these firms and similar business models – solicitors, engineers, vets – to achieve. Profit is the figure after all the “executive” functions have been paid and we should be aiming at a 20 per cent profit margin.

Billingham1-17Apr14
Current split between advice costs, administration and profitability
Billingham2-17Apr14
Target split between cost of advice, cost of administration and profitability

We believe the cost of advice should be closer to 40 per cent of turnover, with expenses being held to 40 per cent. Looking at Jane’s figures, we quickly see that cost of advice is low while the expenses are running at 60 per cent of turnover. We clearly need to look at this area in more detail. There may be a number of reasons for this:

  • Lots of legacy small cases that soak up admin with little profit
  • Overdelivery of service to currently unprofitable clients
  • One of the paraplanners may actually be defacto part of the giving advice system but everything goes through Jane
  • The systems may be clunky, with cumbersome compliance and a lack of efficiency

In reality, we are likely to see a little of all of the above.

The difficulty for the Jane’s of this world is that many of them are in business by accident and have built an “adviser support business” whose role is simply to look after the bits of the job – admin and compliance – they do not want to do. This leads to a natural tendency to leave the back office alone, blame the FCA for their high costs and concentrate on going out to get new business.  And of course, it never ever does.

So what can Jane do? Actually, this is an example where fairly minor tweaks may produce good outcomes. We say do less better:

  • Cut down the over-engineered compliance
  • Authorise a paraplanner to deal directly with “C” clients
  • Reduce service levels where these do not add value 
  • Charge more – you are worth it
  • Have a company-wide “trim the costs’ drive, with a share being paid to staff as a bonus.

Let’s look at that last point in more detail. We currently have to generate £30,000 turnover to fund that £18,000 in admin and £180,000 in turnover to generate that £18,000 in profit. On paper, it seems easier to cut costs. But perhaps not emotionally and we need to manage the message to staff very carefully. So costs creep up.

How do we increase profitability?

  • Charge more – you are worth it
  • Use our time better – 80 per cent plus chargeable time for advisers
  • Slicker systems that fit the model
  • Less but more robust compliance. No tick box
  • Manage costs down where possible

Phil Billingham is a chartered financial planner and director of the Phil Billingham Partnership

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