"It's simple: To raise your firm to a world-class level, you need a world-class financial system. There is no substitute for it and no way around it."

More Than Numbers

By John Bowen

As a financial advisor, you're adept at formulating comprehensive investment plans to meet the unique needs of your clients. You're also capable of managing client relationships so that your clients remain on a disciplined track for achieving their most important goals.

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But when it comes to achieving your firm's most important goals, do you take the same kind of systematic approach? Do you apply the same vigorous discipline to ensure you remain on track? If you're like most advisors, your honest answer would have to be "no."

In my experience, most advisors fail to do a good job "working the numbers" in their own businesses. They are often so busy working in the business that they believe they don't have any time to work on the business. This problem becomes evident when I see advisors with high gross revenues, yet mediocre net incomes. Despite being great advisors, they don't have the kind of financial system that will enable them to build a great business that provides a substantial net income.

It's simple: To raise your firm to a world-class level, you need a world-class financial system. There is no substitute for it and no way around it. A good financial system will provide you with two important results—actionable information and someone who can hold you accountable to the numbers.

Actionable information. The raw financial data is of little use by itself. A well-designed financial system will provide context and perspective around that data, thus enabling advisors to make informed decisions about every aspect of their businesses.

Someone to hold you accountable to the numbers. At the heart of every good financial system is a strong chief financial officer. A CFO will provide a disciplined approach to your finances, requiring you to look problems in the eye and encouraging you to pursue promising opportunities. By setting this high standard, a CFO ensures that your business consistently functions at an optimal level.

Ideally, you've created a detailed set of financial projections as part of your firm's business plan. These projections will form the essential foundation of your financial system, but they are still just one part of it. To create a highly effective system that can drive the planning business to succeed, you (or more precisely, your CFO) must incorporate each of the following five elements: financial forecast, benchmarks, financial reporting, financial controls and valuation model/exit analysis.

1. Financial forecast. Your financial forecast translates your business plan into a financial model. The business plan must come first, of course, but unless the plan is translated into financial information, you will have no way of determining if you're on or off track, if you've achieved any of your goals or how you should respond to new opportunities.

A financial forecast provides detailed information that projects how your advisory business will operate over the next 24 months. A sound forecast is driven by explicit assumptions about the business. By building from these assumptions, you take a bottom-up approach—separating the business into its pieces and evaluating if your implicit assumptions actually make sense. This is distinct from the top-down, back-of-a-napkin approach most financial advisors use, which simply assumes that certain levels of revenue and profit are achievable, without closely examining how they will be achieved.

There are six important elements of the financial forecast:

Revenue forecast. This forecast provides the results for all of the assumptions that have been developed for each of the unique revenue streams of the advisory business.

Budget for compensation and staffing. This budget looks at current compensation and benefits for existing staff, your compensation plan over the next two years for existing staff and any new hiring that you plan on doing over the coming 24 months.

Operating expenses. A forecast should include a discrete budget for each area of spending, including sales, marketing, administrative and general expenses.

Balance sheet. The balance sheet provides a snapshot of your firm's various assets (primary current assets include cash, marketable securities and accounts receivables) as well as its liabilities.

Cash flow statement. Your assets and liabilities, when tied together on the cash flow statement, show how much cash you anticipate having access to.

Financial snapshots. These presentation elements of the financial system typically include a written summary, profit/loss statement, and key benchmarks (such as assets under management, total number of clients and how much the business is earning per professional staff). Charts display revenue, EBITA (earnings before interest, taxes and amortization), and the growth of various revenue streams, all at a glance.

2. Benchmarks. Your financial system should illustrate the goals for your business. Again, it's just not enough for you to take a back-of-a-napkin revenue assumption and say, "As long as our revenue is moving from X to Y to Z, then we'll be fine." More often than not, these types of blanket assumptions don't play out correctly in the real world.

A well-crafted financial system will instead base its assumptions on the actual results that you must have to achieve your goals. It will weave together the parts of the business plan to understand what the plan really means and what it yields in profit. And it will provide benchmarks for revenue, expenses and cash flow, all based on what you need to achieve.

To determine revenue benchmarks, you must answer specific questions:

• In order to grow my revenue, what are the specific services I will offer?
• How will I grow my client base?
• How much revenue will I be able to earn from each client?

For expenses, you'll answer a different set of questions:

• What staffing levels do I need to achieve my numbers?
• What number of new clients forces us to add another administrative staff person?
• For the expense inherent in each senior partner, how much in additional assets should each partner bring in each quarter?

The last essential element to benchmarking is the cash flow of the business. After all, if your business runs out of money, that's the end of the business. On the other hand, if the business has sufficient cash, you and your staff will earn distributions and bonuses that will amply reward your efforts.

3. Financial reporting. In addition to understanding the many assumptions driving the growth of the business, you also need to take snapshots of the business periodically to see how it's actually doing. Have you achieved the results that you wanted to? Are you doing better, or are you falling short?

On a quarterly basis (or monthly, as appropriate), you should look closely at your revenue, expenses, cash flow and profit, at a high and at a detailed level. Compare your budgeted figures to actual results. Is there any variance, and if so, what is the percentage of the variance? If an item varies by just a few percentage points, it may not be a concern, but if one of your key revenue streams is off by 50 percent, it certainly should set off alarm bells.

The numbers should immediately tell you which particular areas of your business may need your attention right away. These are important issues to understand quickly because the health of the business is at stake.

In a real sense, these numbers allow you to have a conversation about your business. And the discipline of having those numbers reported to you periodically for your evaluation makes it certain that these important conversations occur. Without this kind of discipline, you will spend most of your time taking care of your clients and bringing in additional assets—and not paying attention to whether you are getting the dollars out of the business that will sustain it for the long run and build value.

4. Financial controls. Everyone's heard the phrase "garbage in, garbage out." If the underlying transactions of your business have not been recorded and categorized properly, then the information you get will be garbage. To ensure the integrity of your information, a world-class financial system will have controls in place in four key areas:

Accounting system. Clearly, it's important that your results accurately reflect what actually occurred in your business. You therefore need procedures in place to ensure that every revenue-generating transaction is properly recorded, all cash is properly recorded, vendor invoices are recorded as they are received and all payments are tracked.

Written policies and procedures. Your financial system should include detailed documentation of your policies on how transactions are entered into the system, how they are double-checked, and who has responsibility for each operation and business process.

Funds disbursement and deposit controls. Unless you have a one-person practice, your firm should not authorize any one person to make both deposits and disbursements. No matter how trustworthy someone may appear to be, separating these two functions removes all temptation and makes it easier for that person to do his or her job.

CPA. Every advisory business should have a CPA to review compliance issues and complex financial transactions, as well as to prepare tax returns.

5. Valuation model/exit analysis. You're not in business only for the ongoing money you earn; you also are working to maximize your firm's value when you choose to exit. For this reason, any world-class financial system should include a pro forma evaluation of the firm.

A good financial system is a baseline requirement for moving your firm to its next level of success. Without one, you will lack the information and analysis you need to understand how your business is actually performing or to make thoughtful decisions about its future. But with a sound financial system in place, you'll be fully equipped to steer your firm to greater success.