As published in No More Practice’s Reality Check on 20 June 2013

For a business to achieve sustainable success, it is vital it delivers healthy profit year on year. Irrespective of whether you own the company or are an employee, focusing on profitable results should be everyone’s business.

In their book, Practice Made Perfect, Mark Tibergien and Rebecca Pomering make a priceless comment when they state: “financial success is defined by profitability, strong cash flow, a healthy balance sheet, fair return for the owner and value that’s transferrable”.

Being able to break down the numbers into simple categories, and refer to rules of thumb, ratios or benchmarks provides an easy way to assess the health of your business and pinpoint the problem areas.

Some simple ‘rules of thumb^*’ that Tibergien and Pomering suggest for a financial advice business, are:

• Direct expenses in the vicinity of 40% of total revenue.
• A gross profit margin (gross profit as a percentage of total revenue) of around 60%.
• Operating expenses no more than 25% – 35% of total revenue.
• An operating profit margin (operating profit as a percentage of total revenue) around 25-35%.

 *These figures are rules of thumb only. The key is to ensure that a business owner understands the economics of their business and the environment they operate in.

In theory, here is what these numbers would look like (give or take):

	Dollar amount	Calculation	As a percentage of revenue
Revenue	$1,000,000	$1M / $1M	100%
– direct expenses	($400,000)	($400K) / $1M	(40%)
= Gross profit	$600,000	$600K / $1M	60%
– operating expenses	($300,000)	($300K) / $1M	(30%)
= Operating profit	$300,000	$300K / $1M	30%

 

Revenue: from all sources.

Direct expenses: the costs directly associated with the generation of revenue by all professional staff including their salaries, bonuses and incentives.  It also includes fees paid for referrals.

Gross profit: Revenue less direct expenses.

Operating expenses: Overhead expenses such as rent, IT, equipment, stationary, insurance, marketing, training etc. Administrative and management position remuneration packages are included here.

Operating Profit: Gross profit, less operating expenses.

Interpreting the results

Using the above approach, here are the 7 killers of profit to look out for.

If the gross profit margin is declining, the culprits include:

1. Unprofitable pricing.  Not being paid what you are worth.

2. Declining productivity. The easiest way to track and measure productivity is to use ratios or metrics and capture their relative performance on an ongoing basis. The simplest ones are:

• Revenue per Adviser and revenue per FTE (full time equivalent)
• Operating profit per Adviser and operating profit per FTE

3. The wrong mix of clients. This is when 20% of your clients subsidise the other 80%.

4. No defined ‘offer’. Trying to be all things to all people without clearly defined target clients/groups and an offer that addresses their specific needs.

The factors that cause the operating profit margin to fall, include:

5. A decline in the gross profit margin as outlined above.

6. Ineffective expense management. Addressing this requires discipline, closely managing costs and sticking to a well thought out budget. Seems simple, yet so few do it properly.

7. Not enough revenue (by volume) to support your operating infrastructure.

The key is being able to recognise and understand what the numbers are highlighting. The relative trends and benchmarks are of most value in diagnosing problems and finding the best solutions.

If managing the financial performance of your business has not been actively undertaken, there is nothing like starting today. The insight it provides is ‘gold’ to help determine which parts of your business are profitable and which parts need attention, sooner rather than later.

After all, most businesses owners do not go into business to break even!