“Revenue is vanity, cash flow is sanity, but cash is king.” It’s an age-old business maxim that too few independent advisors ever fully embrace. As firm owners, many of you have endured personal and financial sacrifices for years in order to establish and grow your practices. It’s only natural to want to enjoy the fruits of your labor when you finally turn a corner and annual profitability continues to rise. The inclination to equate the firm’s net income to your personal income can be strong. In fact, it’s not at all uncommon for advisor owners to be extracting close to 100% of their annual net income out of the business. Unfortunately, that can be a tremendous mistake!
Certainly, you should compensate yourself competitively for your labor. You’ll want to make sure that you pay yourself a fair salary with appropriate variable compensation based on your direct contributions to the firm (e.g., generating new revenue from existing relationships or bringing in new assets). The same holds true for any partners in the firm. Rather than simply splitting any additional net profits and pulling them out of the firm as additional owner’s compensation, consider retaining at least a portion of those profits as cash in the business.
Retained cash fuels growth
What many wealth management advisors fail to recognize is that extracting all the annual profit out of their practice leaves it highly leveraged and assumes unnecessary risk. Instead, start thinking about retained cash as your firm’s “opportunity war chest” to fund future growth. Retained cash can serve as an accelerator to fund essential human capital expenditures, new technology enhancements, or the expansion of services. It can also be a key ingredient in successfully luring a desired acquisition target.
When the time comes to exit the business, retained cash in your P&L can go a long way towards justifying your enterprise value to a prospective buyer of the firm. Without a clear formula for your compensation and no track-record of retained cash in the firm, any buyer is likely to have significant concerns about the financial advisability of the deal. If they’ve got to go out and pay someone to run the firm, someone else to function as a rainmaker, and someone to serve as a financial advisor to these clients, does the acquisition really make a whole lot of sense?
Managing your cash flow is vital to both the survival of your business as well as to its long-term viability and growth potential. The challenge lies in finding the optimal mix of how much cash you can safely extract from your practice, and how much should be retained in order to fund the continued growth and expansion of the business.
Coaching Questions from this article:
- Take time to examine your owner’s compensation. How are you currently paying yourself? How have you aligned your compensation to the contributions you make to the firm?
- What happens to your firm’s net profits at year-end? Are there growth-related initiatives that those profits might better be earmarked towards?
- What is the likelihood that you would undertake an acquisition should the ideal opportunity arise? What sort of preparations have you made to facilitate that process if it comes to fruition?