Managing other people’s money is what you do, but how do you stack up in terms of managing your own money?
In this article, the next in Ray Griffin’s CPD series, Ray asks to you to get up close and personal with your business expenses and revenue budgets. He’ll ask you the tough questions to ensure you develop an almost instinctive understanding of your cash flow behaves.
Have you ever heard the expression: “Like a plumber with a leaky tap”?
As a financial adviser, do you ever wish you had more hours in the day just so you could keep in top of the financial issues affecting your business? Like the expert plumber who never seems to get around to fixing the tap that’s leaking at his own home, sometimes advisers are prone to lose sight of what’s really going on, financially, in their own business.
It shouldn’t take a Global Financial Crisis for financial advisers to look closely at how their business is performing in the present and into the future. The depth of the market downturns resultant of the GFC directly impacted the revenue streams of any advisers charging fees on an asset basis or earning trailing commissions. Of course, it also saw decreased numbers of new clients.
If you’re an employed adviser, most often you won’t have to be concerned about how the employer’s business is actually performing, but there’s something in this for you too. For those who run their own business either as a representative of a licensee or if they have (or are thinking of applying for) their own Australian Financial Services licence, being on top of your cash flow really is ‘101’.
The bare minimum – ‘Break-Even’
Before reading on – please stop and answer this – in ‘round’ numbers, do you know what your businesses break-even point is?
In other words, do you know what the minimum amount of revenue the business must generate to simply cover all current expenses? How well do you know your business’ expense budget? Have you deduced the total amount of annual expenses down to, for example, the average required revenue per week, per month, per quarter and so on?
If you charge fees on an asset basis, do you know what the impact of say a 10% fall in the Australian share market would be on the business’ income? What about a 25% decline? If not, you should. Break-even calculations are the first step in understanding your business’ cash flow and you need to model a range of scenarios on the downside at varying levels of, for example, declining markets.
For those who levy fees on an hourly rate you need to model the impact of, for example, lost clients. How many clients with average per year fees could you afford to lose before you approach break-even?
Regardless of charging methods, is your business exposed (read: overly dependent) on fees from one or a small number of ‘larger’ clients? Do you know what the impact of losing that client(s) would be to the business? If not you should.
Where will your cash flow be in 3 months from now?
Do you know, within reason, what your business cash flow position will be like in three months from now? As a condition of their licence, holders of Australian Financial Services Licenses must forward calculate their business cash flow on a rolling three months forecast. If it’s a requirement for a licensee to have to do that, then it would seem sensible for all representative financial advisers/planners who operate their own business to do the same. While a three month forecast is part of an AFSL condition, there’s no reason why you couldn’t run your forecasts over say six months and beyond.
Cash flow instinct
This is about getting your mind across the ‘headline’ numbers such that over time you develop an almost instinctive sense of where the business is at; where it’s heading in a cash flow sense and what the risk points and triggers are. Anything else is to simply ‘fly blind’ and hope for the best.
While I’m not suggesting that you yourself should be loading the expense and income data into the spreadsheet, you do need to be looking at those numbers on a regular basis. If you employ someone to do your bookkeeping, you should not abrogate your duties entirely to that person. You shouldn’t be getting cash flow warnings from your bookkeeper – you should be across the issues well before a crisis develops.
While your bookkeeper/accountant is responsible for data entry and reporting, it’s you (and your business partners if relevant) who must be ‘across’ the final numbers and it’s you who needs to be looking for cash flow trends which are developing in a deleterious manner and instinctively know what a, for example, 10% market downturn does to your business.
What’s your plan when things don’t go to plan?
Imagine for a few moments that your business’ revenue declined by 10% (or more). Do you know if the business would remain profitable in that situation? Could it break-even? If it doesn’t remain profitable or if the reduced profit result is too low for you, what actions might you take to address the situation?
- Would you cut costs?
- Would you leave costs alone and look to increase revenue by trying to attract new clients through, say, an advertising campaign?
- Can the business afford the advertising campaign?
- How long will it take for such a campaign to deliver new revenue to the business?
- Can you wait that long?
- What costs would you cut and when?
- What are the downsides of cutting the costs you have identified?
- Would you retrench staff – reduce hours? If so which staff? Who can you most afford to lose?
A suggested course of action if your ‘tap is leaking’
If you’re unable to answer any or all of the preceding questions, then there is some work for you to undertake so let’s look at a straightforward course of action to get you closer to an ‘instinctive’ understanding of your business cash flow.
Develop a spreadsheet which details your FUM in each sector and the fees receivable against those sectors. Then, simply model – say to the left of the FUM sectors on the spreadsheet – various levels of sector declines and the impact on fees. For example, given that in recent times domestic and international markets tend to move in-step with each other, you can model a 10% decline in Australian and international equities and examine the impact on fees. The same might be said for other listed assets such as property funds and the like. Calculate higher levels of decline and note the impact on fees all the way to the ‘bottom line’.
Build in your break-even point as part of the analysis so you can at a glance know where that point is in terms of market declines. A well constructed spreadsheet of this type can become a permanent tool to help you understand how your business will behave under certain market conditions. If it really is well constructed, in terms of cell calculations, you need only enter the ‘Current’ FUM data on say a monthly basis.
The key thing about building your business’ cash flow ‘barometer’ on a spreadsheet is to have an understanding of what you want it to tell you. With almost twenty years in professional practice I can attest that this is one of the best business management tools you can have at your side. It really does give you much greater confidence in knowing what impact markets will have on your business.
With thanks to a former US Secretary of State (Rumsfeld, D.), from a financial planning business perspective, there should not be ‘unknown unknowns’. There should not be unforeseen market movements or at least you shouldn’t get caught asleep at the cash flow wheel when they arrive. We all know markets go up and down and it’s the downside that you must know about in terms of its impact on your business’ cash flow.
By building a quality spreadsheet analysis of your present and forecast cash flow which models the impact of market declines, you will only ever have ‘known unknowns’.