It's time to bring profit back

The Business Health Future Ready V report has revealed that the average profitability of advice practices has plummeted from 28.5 per cent in 2010 to 14.8 per cent in 2012.

Combine that statistic with another finding in the report, that the number of advice businesses with an effective business plan has almost halved, to an astounding low of 28 per cent, and the future does not look good.

Look a little deeper, and you soon realise this is more than just a problem, it's a potential catastrophe.

The figures that are benchmarked in the report use a notional salary of $100,000 for each principal working in the practice, and with no disrespect to Terry, Rod and the Business Health team, in my opinion that figure is way too low. When benchmarking, they need to pick a figure that is easily applicable across the spectrum of participants, but we would caution heavily advisers who are aiming to simulate this notion.

When you consider what you could earn as a salaried financial adviser with an institution, why on earth would you consider $100,000 appropriate when the principal adviser tends to be the most experienced and productive and, when they enable themselves to spend a majority of their time servicing clients, they can generate a significant amount of value for both the clients and the business?

The fact that you have taken the risk to run your own business, to employ staff and, in many cases, to put your butt on the line to create a vehicle through which you can provide quality advice to your clients, should mean that you are rewarded handsomely.

As far as businesses go, advice businesses may not require the capital outlay to fund warehouses or carry perishable stock, but ask anyone who has been on the losing end of a FOS case and you'll get a new understanding of risk, and just how expensive your PI excess can be (and that's when PI actually pays out!).

Perhaps it's time for some tough love ... we've had principals tell us that they take a hit in income because they're thinking of the longer term. They're prepared to reduce their take-home earnings because they are building an asset, and by reinvesting in their business, they can increase the value of that asset.

A noble strategy if they are indeed investing in their business. However, in reality many businesses, especially in the current market, are working on thin margins and rather than investing in advice or technology or marketing, they are simply battling their way through in the hope that they can slowly turn the business around by making incremental changes.

Of course, the other consideration is that principals take a lower salary because they prefer to take their earnings as profit. Again, this is a great strategy if the business is generating significant profits!

Times have changed, and the business models of advice businesses are changing too whether you like it or not. Historical valuations using multiples of recurring income are slowly being replaced by the more traditional (in the sense of other businesses outside of financial advice) valuation methods using EBIT multiples, and with the demise of trail commissions, we would expect this trend to grow.

It comes down to the pure business decision about perceived future value for the purchaser. Don't for a moment expect that the future purchasers of your business will pay you a multiple of the profit based on your calculations. When determining EBIT valuations, purchasers will factor in market-rate salaries prior to re-calculating profit figures in a business, and therefore your asset value that you have been sacrificing salary to reach may not be as big a pot of gold as you think.

When we are helping our clients create their pricing and business models, we assist them to analyse their own expenses in their profit and loss and to factor in the actual fixed costs of their business, as well as the employment costs of their staff.

When the principals are working as an adviser (in addition to their management roles), many have been taking home whatever is left and are unsure about what figures to insert for their own notional salary.

We suggest that anything less than $120K to $150K is too low for an adviser principal base salary.

Look at your business through the eyes of a potential purchaser ... or [use] a strategy we find works well for our clients: consider what might happen if you were injured and unable to work in your business for an extended period of time. In order to employ an adviser to take care of your clients, you will need to pay a market salary - and you'd want to continue earning a profit above that!

After applying a market salary for advisers, the next question is, 'What is the 'right' profit margin to build in?' While this number will vary with the objectives of the principals, we would suggest that aiming for anything less than 30 per cent is, again, selling yourself short and not positioning yourself to be able to handle future adverse business conditions. Most of our advisers aim for somewhere between 30 and 40 per cent, and a large number are enjoying profit margins in excess of this figure.

A critical driver of profitability is the pricing model used by the business. And here's another disturbing statistic that may impact the future of advice businesses.

In our Adviser Pricing Models Research report second edition*, we discovered that of the 433 advice businesses surveyed, there was a significant difference in the figures being charged by advisers who "did a thorough analysis of the costs to deliver their services and took a robust process to determine their pricing" and those who took any other option (reading articles, attending presentations, estimating fees based on instinct, etc).

On average, there was a 27 per cent difference between these two groups in their engagement fees charged, and more concerning, those who hadn't taken a robust process charged over 30 per cent less for their ongoing fees than those who had.

Why is this so disturbing? While we don't believe that higher fees are always better, one would think that those who have taken a robust process would be more likely to have their pricing ' right' than those who estimated. And if these are the same businesses that are only enjoying 14.8 per cent profitability, after principals' salary of $100K per annum, it is pretty evident that they will be running at a loss, if they are not already, as a result of not getting their pricing model right.

*Note that less than five per cent of the participants in our Adviser Pricing Models Research Report had used Elixir services to create their pricing - it was important that this research was a true indication of the market and not influenced by Elixir.

We believe that consumers need quality advice, and for them to be able to access that we need a range of providers in the marketplace - from the institutional players with employed advisers through to the advisers who choose to take all of the risks and rewards of running their own business ... and all of the permutations in between.

Sadly, the statistics indicate that if advisers don't start running their business differently, and empower themselves with the ability to be rewarded handsomely for their entrepreneurialism, their commitment to quality and the risks they are taking to deliver that quality, the future of the independent adviser may indeed be at risk.

Our top four tips to reverse this trend?

1. Stop blaming the markets, or the government, or fund managers, or dealer groups, or anyone and anything else that is not within your control. Look within and find that strength and passion that led you to be a business owner in the first place and start doing things differently! Make sure that you focus ON your business and run it effectively, rather than letting it run you.

2. If you didn't do it right the first time, or you still haven't got around to it, make sure you take a robust process to creating your pricing model. This is more than just using a cost-to-serve calculator. You may find there are enhancements you can make to your service offering and business model that will deliver the results you're looking for.

3. If you don't already have one, write and implement a business plan that will help you gain clarity on what you will do in your business over the next 12 months, and use it properly so that it can keep your team on track. On that note, in our world an effective business plan fits on one page, is referred to regularly, and results in a minimum 85 per cent achievement of the targets set within it.

4. You don't need to go it alone. If you don't know how to turn your business around, or you have great ideas but are looking for a confidante to thrash them out with, or you and your team need someone who can help you stay accountable, then for the sake of your future, seek out a business coach who can help you. If you get the right one, the benefits and uplift in your business will far outweigh the investment!

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About Sue Viskovic

Sue Viskovic CFP is the founder of Elixir Consulting; a proud mother of four; a sought-after speaker; a business coach; and author of a number of books and programs designed for advisers.

She is a former chair of the Western Australia chapter of the Financial Planning Association (FPA), manager at Prosperity Advisers and a practice development manager at Bridges Financial Services.