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The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
The Method Behind The Madness
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The Method Behind The Madness

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2009 FPA NexGen Anaheim presentation on various scenarios within a financial advisory practice and the impact of those transitions on the income statement.

2009 FPA NexGen Anaheim presentation on various scenarios within a financial advisory practice and the impact of those transitions on the income statement.

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  • 1. The Method Behind the Madness<br />Why the Owners Make the Decisions They Do<br />
  • 2. What we’ll cover today<br />Overview from NexGen 2007<br />What is the Income Statement?<br />Components of the Income Statement?<br />What is/are:<br />Common sizing?<br />Running trend analysis?<br />Benchmarking?<br />Comparison of bull & bear markets<br />Fast forward from NexGen 2007 to NexGen 2009<br />How did the projections play out?<br />What worked, what didn’t<br />What are the implications going forward?<br />
  • 3. Purpose of this presentation<br />To raise awareness of the financials inside a practice<br />Expose younger advisors to financial management concepts<br />To help you “add value” to your firm and look for areas of improvement within the practice<br />To understand how bull & bear markets affect the management decisions within a firm<br />
  • 4. Excellent Leaders Control the “Big 3”<br />Finance:finance is the prime means of executive control in any organization<br />Personnel:selection of people will determinethe organization<br />Planning:this area determines the future of the organization<br />Source: “Developing the Leader Within You” by John Maxwell<br />
  • 5. Why Focus on Financial Management?<br />How do we answer the question “Tell me about your practice?”<br />Assets Under Management<br />Revenue<br />Business style – Fee-based, Fee-only, etc.<br />Many of the concepts for this presentation come from “Practice Made Perfect” by Mark Tibergien and Rebecca Pomering<br />
  • 6. Why Focus on Financial Management?<br />In reality, Financial Success is determined by:<br />Profitability<br />Cash Flow<br />Return to the owner<br />Value that can be transferred to the next owner<br />Many of the concepts for this presentation come from “Practice Made Perfect” by Mark Tibergien and Rebecca Pomering<br />
  • 7. The Tools of Financial Management<br />Balance Sheet<br />Income Statement (a.k.a. Profit & Loss)<br />Statement of Cash Flows<br />We’ll be focusing on the Income Statement in this presentation<br />
  • 8. Why the Income Statement?<br />It’s a great tool to keep score –shows both revenue and profits<br />Both are critical to know<br />The classic example, two firms, both have $1MM of revenue<br />One has profit of $50,000<br />The other has profit of $250,000<br />There are two very different stories within those practices<br />If you know how to interpret the different components, it yields invaluable insight into how the organization functions.<br />
  • 9. How do people look at owner’s income?<br />Revenue $1,000,000<br />Expenses $ 400,000<br />Owner’s Income $ 600,000<br /><ul><li>This is okay to determine how much the owner makes
  • 10. This doesn’t work for managing the business. It doesn’t paint a clear picture of what is happening within the firm</li></li></ul><li>A Refresher On The Income Statement<br />Remember the accounting classes you slept through…<br />Somewhere in there, they discussed The Income Statement<br />Revenue $1,000,000<br />Cost of Goods Sold $ 400,000<br />Gross Margin $ 600,000<br />Operating Expenses $ 400,000<br />Net Income before Interest and taxes $ 200,000<br />
  • 11. Applying The Income Statement<br />What changes when you look at an advisory practice?<br />Revenue $1,000,000<br />Direct Expense (Cost of Goods Sold) $ 400,000<br />Advisor compensation (salary & incentive)<br />Gross Profit (Gross Margin) $ 600,000<br />Operating Expenses $ 400,000<br />All Other Costs<br />Operating Income (Net Inc before Int & taxes) $ 200,000<br />Reward to business owner for accepting business risk<br />
  • 12. Common Sizing<br />Common sizing – take each line item, and divide it into the total revenue, expressed as a %<br />The ratios help to define what is going on in the firm<br />Revenue $1,000,000 100%<br />Direct Expense $ 400,000 40%<br />Gross Profit $ 600,000 60%<br />Operating Expenses $ 400,000 40%<br />Operating Income $ 200,000 20%<br />
  • 13. What is Running Trend Analysis?<br />Running Trend Analysis – A comparative analysis of a firm’s financial ratios over time<br />You need to common size, then track the ratios over time<br />Monitor trends to determine areas which may need attention<br />It can also be used in forecasting the impact of a decision<br />
  • 14. An Example of Running Trend Analysis<br />
  • 15. What is Benchmarking?<br />From Encarta:<br />Benchmark – a standard against which something can be measured or assessed<br />You “benchmark” against firms of similar size or style of business to analyze efficiency and profitability<br />Many different sources of data are available, some of which are listed at the end of this presentation<br />We’ll be incorporating benchmarking throughout this presentation<br />
  • 16. The Average Advisory Income Statement<br />Revenue $1,090,747 100%<br />Direct Expense $ 435,208 39.9%<br />Advisor compensation<br />Gross Profit $ 666,446 60.1%<br />Operating Expense $ 453,750 41.6%<br />All other expenses<br />Operating Income $ 212,695 18.5% <br />Reward to business owner for accepting business risk<br />Source: 2005 FPA Staffing & Compensation Study by Moss Adams<br />
  • 17. Some Scenarios to Illustrate the Concepts<br />The growth of the company calls for a well developed Human Capital Plan<br />The growth curve of the client base demands more advisors – how does a new planner affect the bottom line?<br />The firm is big enough to start working in another equity partner - what happens to the principal’s income?<br />
  • 18. The Impact of the Human Capital Plan on the Income Statement<br />Let’s assume that the two founding principles are drowning trying to keep up with servicing a growing client base<br />They go to a conference, and find some time to review their business and how to address the issue above<br />After some discussion, they decide it’s time to hire a new, entry level planner to mentor<br />They review a compensation study, and decide that a salary of $45,000 per year is a good starting point.<br />Let’s take a look at the impact of the decision on the income statement of an average $1MM advisory firm<br />
  • 19. How does this hiring decision affect the Income Statement?<br />BeforeAfter<br />Revenue 100.0% 100.0%<br />Direct Expense <br />Owner’s Compensation 39.9% 39.9%<br />Non-Owner’s Compensation 0.0%4.5%<br />Total Direct Expense 39.9% 44.4%<br />Gross Profit 60.1% 55.6% <br />Operating Expense 41.6%41.6%<br />Operating Income 18.5% 14.0%<br /><ul><li>Note how advisor compensation falls under direct expense
  • 20. Note the decrease in Gross Profit, as well as Operating Income </li></li></ul><li>The Impact on the Income Statement<br />If the staff planner gets a salary of $45,000 per year, what are the other costs associated with the hire?<br />401(k)<br />Payroll taxes<br />Health, Life and Disability Insurance<br />Continuing Ed<br />Other…<br />
  • 21. What’s the actual cost?<br /><ul><li>Salary = $45,000
  • 22. 401(k) match (4% of salary) = $ 1,800
  • 23. Health insurance = $ 1,200
  • 24. Life and Disability insurance = $ 300
  • 25. Continuing ed = $ 2,000
  • 26. Payroll taxes (7.65% of salary) = $ 3,442
  • 27. Total cost of the employee = $53,742</li></li></ul><li>The Impact on the Income Statement<br />Salary falls under Direct Expense<br />What about benefits and other costs?<br />Those costs fall under overhead expense<br />The difference between the salary of $45,000 and the total employment cost of $53,742 flows into several different line items on the income statement in overhead expense<br />
  • 28. The Impact on the Income Statement<br />BeforeAfter<br />Revenue 100.0% 100.0%<br />Direct Expense <br />Owner’s Compensation 39.9% 39.9%<br /> Non-Owner’s Compensation 0.0%4.5%<br /> Total Direct Expense 39.9% 44.4%<br />Gross Profit 60.1% 55.6% <br />Operating Expense <br />Additional Overhead Expense 0.0% 0.9% <br /> All Other Overhead 41.6%41.6%<br /> Total Overhead Expense 41.6% 42.5%<br />Operating Income 18.5% 13.1%<br />
  • 29. The Owner’s perspective on a new hire<br /><ul><li>If we invest $53,742 per year into a staff planner, what type of return will we receive for our investment?
  • 30. How long before direct expenses and operating profits get back to where they were?
  • 31. What are we hiring/looking for?
  • 32. Client service skills
  • 33. Business generation skills
  • 34. Technical planning skills
  • 35. Portfolio management skills
  • 36. Leadership and management ability
  • 37. Openness to feedback and coaching?
  • 38. Other skills and abilities…</li></li></ul><li>The staff planner’s perspective<br /><ul><li>I may be able to make more than $45,000 per year at another firm.
  • 39. As I help to build revenues, how am I compensated?
  • 40. As I help to increase the business value of the firm, how am I compensated?
  • 41. Does the business fit the profile I am looking for…?
  • 42. What are the values and philosophies of the firm?
  • 43. Are the owner’s good mentors, leaders, and managers?
  • 44. Are there well-defined career tracks to follow?
  • 45. Is there any flexibility?
  • 46. Will I be heard, and will the work I produce be valued?</li></li></ul><li>The Impact on the Income Statement<br /><ul><li>How does adding a staff planner affect the income statement over time?
  • 47. Who gets paid what, and when?
  • 48. Let’s assume we have 20% year over year revenue growth</li></ul>Year 1Year 2Year 3<br />Revenue $1,000,000 100.0% $1,200,000 100.0% $1,440,000 100.0%<br />Direct Expense <br />Owner’s Comp. $ 399,000 39.9% $ 450,000 37.5% $ 495,000 34.4%<br />Non-Owner’s Comp. $ 45,000 4.5%$ 55,000 4.6%$ 65,000 4.5%<br />Gross Profit $ 556,000 55.6% $ 695,000 57.9% $ 880,000 61.1%<br />Operating Expense $ 425,000 42.5%$ 504,000 42.0%$ 597,600 41.5% Operating Income $ 131,000 13.1% $ 191,000 15.9% $ 282,400 19.6%<br />
  • 49. The Impact on the Income Statement<br /><ul><li>What are the running trends, and how do they compare to the benchmarks? </li></ul>Year 1Year 2Year 3<br />Revenue $1,000,000 100.0% $1,200,000 100.0% $1,440,000 100.0%<br />Direct Expense $ 444,000 44.4%$ 505,000 42.1%$ 560,000 38.9%<br />Gross Profit $ 556,000 55.6% $ 695,000 57.9% $ 880,000 61.1%<br />Operating Expense $ 425,000 42.5%$ 504,000 42.0%$ 597,600 41.5%<br />Operating Income $ 131,000 13.1% $ 191,000 15.9% $ 282,400 19.6%<br /><ul><li>At growth of 20% per year, at the end of Year 3, the firm will have Operating Income of 19.6%, compared to the benchmark of 18.5%.
  • 50. In this scenario, everybody wins… But is 20% year over year growth achievable?</li></li></ul><li>A Visual of the Growth Scenario<br />This is sweet – let’s hire another one!!!<br />
  • 51. The Impact on the Income Statement<br />What does it take to grow at 20% per year?<br />Let’s assume the market is flat (AUM Model)<br />Revenue increases at $200,000 + per year<br />If your average fee is 1%, that means $20,000,000 of new assets<br />If your average client has $750,000 of AUM, that means 26.67 new clients per year, or one every two weeks<br />If the group can do that, you have a win-win!!!<br />
  • 52. The Impact on the Income Statement<br />That was the 20% growth scenario<br />But what if the bottom drops out of the market again (’73-74 & ’00-’02)?<br />Remember, this firm runs on a % of AUM<br />This time, let’s assume a 10% decline due to an extended bear market<br />Remember this slide – this was done in 2007 – we’ll be comparing this to what actually happened in the second ½ of the presentation…<br />
  • 53. The Impact on the Income Statement<br /><ul><li>How does adding a staff planner affect the income statement over time?</li></ul>Year 1Year 2Year 3<br />Revenue $1,000,000 100.0% $ 900,000 100.0% $ 810,000 100.0%<br />Direct Expense <br />Owner’s Comp. $ 399,000 39.9% $ 399,000 44.3% $ 399,000 49.3%<br />Non-Owner’s Comp. $ 45,000 4.5%$ 45,000 5.0%$ 45,000 5.6%<br />Gross Profit $ 556,000 55.6% $ 456,0000 50.7% $ 366,000 45.2%<br />Operating Expense $ 425,000 41.6%$ 425,000 46.2%$ 425,000 51.4%<br />Operating Income $ 131,000 13.1% $ 31,000 3.4% $ - 59,000 - 7.3%<br />
  • 54. A Visual of the Decline Scenario<br />This is not what we had in mind…<br />
  • 55. A Comparison of Year 3 between the scenarios:<br />Year 3Year 3<br />Revenue $1,440,000 100.0% $ 810,000 100.0% <br />Direct Expense <br />Owner’s Comp. $ 495,000 34.4% $ 399,000 49.3%<br />Non-Owner’s Comp. $ 65,000 4.5%$ 45,000 5.6%<br />Gross Profit $ 880,000 61.1% $ 341,000 45.1%<br />Operating Expense $ 597,600 41.5%$ 425,000 52.4%<br />Operating Income $ 282,800 19.6% $ - 59,000 - 7.3%<br />The point is that profits aren’t automatic – business risk does exist!!!!<br />
  • 56. A Comparison of the Scenarios<br />Let’s hire another one!!!<br />What was the name of that truck driving school…?<br />
  • 57. The Impact on the Income Statement<br />In the bear market scenario, Operating Income disappears.<br />No ownership distributions<br />Capital needs to come back into the firm<br />No salary increases for the owners or the staff<br />The comparison illustrates how important it is to grow aggressively if you are bringing new staff on board<br />
  • 58. The Impact on the Income Statement<br />Some Assumptions:<br />Let’s use the 20% growth scenario, beginning in Year 2<br />The two founding Principles decide to bring in one of the staff planners as a junior equity partner.<br />They agree to sell a 20% stake in the firm<br />The buyer will finance the purchase with a loan from the bank, and use ownership distributions to pay off the note.<br />What happens to the principles ownership distributions?<br />
  • 59. The Impact the Income Statement<br />Year 2Year 3<br />Revenue $1,200,000 100.0% $1,440,000 100.0%<br />Direct Expense <br />Owner’s Comp. $ 450,000 37.5% $ 495,000 34.4%<br />Non-Owner’s Comp. $ 55,000 6.7%$ 65,000 4.5%<br />Gross Profit $ 695,000 57.9% $ 880,000 61.1%<br />Operating Expense $ 504,000 42.0%$ 597,600 41.5%<br />Operating Income $ 191,000 15.9%$ 282,400 19.6%<br />Principle 1 Distributions: $ 95,900 $ 112,960<br />Principle 2 Distributions: $ 95,900 $ 112,960<br />Jr. Partner Distributions: $ 0 $ 56,480<br />
  • 60. The Impact of the Succession Plan on the Income Statement<br />In the 20% growth scenario, everybody wins!!!<br />Base salaries can be increased due to increasing revenues<br />Operating Income increases enough so that the founding principles ownership distributions continue to increase<br />O.I. increases enough that the junior partners ownership distributions can pay the loan.<br />
  • 61. The Impact on the Income Statement<br />Now, let’s take a look at what happens if growth stops…<br />We’ll start at Year 2 of the Growth Scenario<br />This time however, we’ll drop results by 10% beginning in Year 3. <br />Same 20% ownership transfer and deal structure as in the growth scenario.<br />
  • 62. The Impact on the Income Statement<br />Year 2Year 3Year 4<br />Revenue $1,200,000 100.0% $1,080,000 100.0% $ 972,000 100.0%<br />Direct Expense <br />Owner’s Comp. $ 450,000 37.5% $ 450,000 41.7% $ 450,000 46.3%<br />Non-Owner’s Comp. $ 55,000 4.6% $ 55,000 5.1%$ 55,000 5.7%<br />Gross Profit $ 695,000 57.9% $ 575,000 53.2% $ 467,000 48.0%<br />Operating Expense $ 504,000 42.0%$ 504,000 46.7%$ 504,000 51.9%<br />Operating Income $ 191,000 15.9% $ 71,000 1.7% $ -37,000 -3.8%<br />Principle 1 Distributions: $ 95,500 $ 28,400 $ 0<br />Principle 2 Distributions: $ 95,500 $ 28,400 $ 0<br />Junior Partner Distributions: $ 0 $ 14,200 $ 0 <br />
  • 63. The Impact on the Income Statement<br />Growth Scenario<br />Year 2Year 3<br />Operating Income $191,000 $282,400<br />Principle 1 Distributions: $ 95,900 $ 112,960<br />Principle 2 Distributions: $ 95,900 $ 112,960<br />Junior Partner Distributions $ 0 $ 56,480<br />Bear Market Scenario<br />Year 2Year 3Year 4<br />Operating Income $ 191,000 $ 71,000 $ -37,000<br />Principle 1 Distributions: $ 95,900 $ 28,400 $ 0<br />Principle 2 Distributions: $ 95,900 $ 28,400 $ 0<br />Junior Partner Distributions: $ 0 $ 14,200 $ 0<br />
  • 64. The Impact on the Income Statement<br />What are the implications of a lack of profit available for distributions?<br />What decisions need to be made within the practice for the succession plan to remain intact?<br />Where to look into the Income Statement for adjustments?<br />
  • 65. Fast Forward to 2008<br /><ul><li>Assumption used in the Bear Market scenario:
  • 66. 10% revenue decline for 3 years
  • 67. Objections to the assumption:
  • 68. We bring in new clients so fast, revenue won’t go down
  • 69. Our investment performance will help out
  • 70. We almost never lose clients
  • 71. A bear market won’t last that long
  • 72. I’m sure there were others….</li></li></ul><li>Fast Forward to 2009<br /><ul><li>Assumptions used in the Bear Market scenario:
  • 73. 10% revenue decline for 3 years
  • 74. S&P 500 Returns for the period 10/1/07 – 3/30/09
  • 75. 10/1/07 – 12/31/07 -3.33%
  • 76. 1/1/08 – 3/31/08 -9.44%
  • 77. 4/1/08 – 6/30/08 -2.73%
  • 78. 7/1/08 – 9/30/08 -8.37%
  • 79. 10/1/08 – 12/31/08 -21.94%
  • 80. 1/1/09 – 3/31/08 -11.01%
  • 81. Cumulative return -46.6%
  • 82. It didn’t take three years – 9/08–3/09 pretty much blew that out of the water….</li></li></ul><li>Fast Forward to 2009<br />The Assumptions:<br />Average client allocation – 50/50<br />Just to make it simple<br />Client contributions = client distributions<br /># of new clients = # of lost clients<br />Basically, let’s try to isolate the market impact on the firm<br />
  • 83. The ‘07 NexGen #’s<br />It took 3 years to be negative<br />
  • 84. The ‘09 NexGen #’s<br />It took 4 quarters to be negative<br />
  • 85. What are the implications?<br />Just like with client portfolios, volatility and market movement matters<br />You need to manage your cash flows (distributions) proactively<br />You need to plan, and then monitor and review<br />
  • 86. What are some strategies?<br />Project out cash flow for 6 quarters<br />Manage cash flows & expenses proactively<br />Create a management dashboard of important ratios, review quarterly<br />Cash reserve<br />Variable/incentive income<br />Revenue Insurance<br />
  • 87. Some Productivity Ratios<br />Active clients per professional<br />Active clients per staff<br />Revenue per professional<br />Revenue per staff<br />AUM per professional<br />AUM per staff<br />Revenue per active client<br />AUM per active client<br />Operating profit per active client<br />
  • 88. Some Productivity Ratios<br />Track and monitor these ratios<br />When considering hiring, pricing, client selection, etc. – make some projections to see how the ratios will be affected<br />Refer to various studies to benchmark your firm against similar firms<br />
  • 89. Resources for further information<br />FPA<br />NAPFA<br />Quantuvis<br />Moss Adams<br />Advisor Impact<br />Others…<br />
  • 90. Thank you for attending<br />Questions?<br />

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