While working as a financial advisor can be attractive based on the ability to make a positive difference in clients’ lives, at the end of the day it is a business and the source of a firm owner’s livelihood. Amidst this backdrop, it’s important for firm owners to pay close attention to their profitability, as it not only helps determine their current-year income but also can serve as a buffer against adverse events (such as a major market downturn, a client lawsuit, or a regulatory action) that could massively disrupt the business.
In this guest post, Matthew Jarvis and Micah Shilanski, who now coach advisors through The Perfect RIA platform based on practices they successfully implemented in their own firms, discuss how advisors can measure their true profitability, create a client-by-client revenue report, and determine when it’s time to ‘graduate’ clients who are no longer a good fit (as well as how to approach this difficult conversation).
To calculate their profitability, a firm owner can start by determining their “True Gross”, or the total amount of money paid by clients, which includes not only financial planning fees, but also investment fees, platform fees, fund expenses, etc. (to get a picture of the total amount a client is willing to pay for the stack of services the advisor offers). Next, the advisor can calculate their “True Net”, which is all of the money that flows through to the advisor’s tax return from their practice (which could be some combination of wages, profits, owner’s distributions, guaranteed payments, etc). Finally, the owner can determine their profitability by dividing their True Net by their True Gross, aiming for at least 30% profitability – with 50% being ideal.
With a profitability figure in hand, firm owners can next use a “Red/Yellow/Green report” to sort their client base by revenue and identify clients who aren’t meeting the firm’s revenue-per-client targets. This exercise involves listing all client households, all revenues collected for each household over the last 12 months, and the assets managed by the firm. After determining the (ideal and realistic) per-client revenue target that they would like to reach, the advisor can then better identify those whose revenues already meet the desired target (“green” clients), those who fall between the ideal client revenue figure and one-half of this amount (“yellow” clients), and those whose revenues fall below one-half of the ideal amount.
“Green” clients are ideal and will be good candidates to remain with the firm going forward. “Yellow” clients can be given an ‘upgrade or graduate’ discussion, where they are given the opportunity to pay a fee that better reflects the value the advisor provides – or to find an advisor better suited to their needs. “Red” clients, with few exceptions (e.g., keeping 5 of these clients for every 100 in the firm’s client base), get put on the ‘graduation’ list, with the advisor offering a specific and authentic rationale for no longer being able to serve them and providing a way for them to find an advisory home that better fits their situation.
Ultimately, the key point is that while it can be tempting for firm owners to assume that they have healthy profitability (particularly when market performance is strong and buoys fees), it’s a valuable practice to take stock of the firm’s true profitability – to ensure sufficient cushion to protect against future contingencies, and to identify ways to increase profit margins into the future.
