News & Insights Client satisfaction: profit does not make!

Starting your own financial advice practice is often done with several goals in mind, building something successful, supporting people needing advice, and making a difference to families and the wider community. However, at a rudimentary level business owners strive to be profitable, keeping costs down and revenue up, often working towards an end goal of selling their practice and enjoying a financially stress-free retirement. To achieve this dream, business owners need to build efficient, profitable businesses that attract and retain happy customers.

Business Health, a leading business diagnostic consultancy firm, recently compiled their research paper Practice Management by the Numbers, which looked at 7 key marketplace metrics for the financial advice industry. Two of these metrics highlighted an ongoing conundrum for financial planning practice owners; client satisfaction does not automatically translate into practice profitability.

Business owners need satisfied customers. This seems simple to achieve on the surface if you provide clients the product they want, build engaging relationships and provide great service. Encouragingly, the research report indicates that practice owners are getting this right.  Client satisfaction ratings are very strong amongst the Australian financial planning industry, with an average of 4.23 out of 5 rating from the 300,000 individuals who completed the Business Health CATScan client survey. So, whilst the industry still faces the challenge of how to increase the number of individuals seeking advice in Australia, financial planners are keeping them engaged and satisfied when they do.

While advisers are kicking goals on the more altruistic objectives of owning a business, the marketplace metric relating to profit presents a slightly different story, which could provide challenges for practice owners who want to capitalise on their years of hard work and sell their practice.

The Business Health Check diagnostic tool shows that the average profit of a planning practice in Australia is 28.2%. Debate around a suitable profit margin varies depending on the industry, value proposition of a business and the commoditisation value of the service provided. Relative to the average profit margins across all industries, 28.2% profitability is a healthy number. However, whether it is a figure that would be attractive to buyers is up for debate. Stephen Prendeville of Forte Asset Solutions has years of experience helping advice practices prepare for sale or acquisition and questions whether a 28.2% profit margin offers the sale value expected by many longer-term practice owners in Australia.

There are two methods consistently used to value a financial planning business: multiple of revenue and EBIT. The industry has for a long time utilised the multiple of revenue model and many still focus on the traditional view of trying to achieve an average of 3x revenue. Buyers have become more astute over the years and we have seen this multiple adjust to consider aspects such as product category, client age, fee models, etc. The maturity of the buyer due diligence process continues to develop, and Stephen Prendeville has highlighted that there is a decided shift towards an EBIT model in recent times. He believes this provides a real dilemma and challenge to practice owners considering their departure or succession planning options. Specifically, with those who are expecting 3x revenue.

Calculations by Forte Asset Solutions show that for a business owner to achieve the equivalent of 3x recurring revenue, under an EBIT model buying approach they would need a profit margin of around 40%. Considering that the average profit margin amongst planning practices is 28.2%, and arguably lower if a buyer was purchasing a ‘renovators dream’, this creates a very large disparity between possible expectations of sellers and the reality of an offer price. So, what does this mean to those hoping to sell in the next few years?

In the first instance, it is imperative that a business owner understands the cost of manufacturing their service and the eventual effect on the profit margin of their business. With a clear understanding of the contributors to their current profit margin, and an acceptance that the days of a simple buying model of 3x multiple are ending, practice owners have two clear choices. They can adjust expectations and accept that a lower profit margin will likely impact their final payout or they can focus on the underlying contributors to profit.

Client satisfaction is undoubtedly important as it supports client retention and increases referrals. But there are many other factors that can affect how profitable a practice is, including salaries, the number of advisers per client, rent and of course the efficiency of the business. Take the time to really understand these factors and a financially stress-free retirement could still be a reality. Measuring and evaluating your business against these performance metrics and other businesses in the industry allows you to take the necessary steps to improve your business performance, and put your practice on the path to increased profitability and a better long-term outcome for a future business sale.

For the full research report including tips on how to improve your business metrics visit www.praemium.com/keymetrics.