The RIA Growth Illusion: How to create a financial model to drive organic growth

For the ten years between 2012 – 2021, wealth management firms experienced a nearly $30 trillion surge in AUM (from $20.6 trillion to $50.4 trillion). Yet during that same decade, global markets experienced an unprecedented 14% average annual growth rate.¹ How do those two data points connect?

According to a 2023 analysis conducted by McKinsey & Company, nearly three-quarters (70%) of industry-wide asset growth resulted from capital market performance. And much of the remaining 30% was due to acquisitive growth.¹ In short, much of the organic growth many firms believe they’ve achieved over the past decade is more smoke than substance.

70%

The past decade’s RIA growth is attributable to market appreciation rather than net new assets

Day in and day out, you counsel clients on the critical importance of having a financial plan. Yet, how much time do you devote to conducting thoughtful financial modeling for your business? Have you ever sat down and modeled multiple ‘what if’ scenarios that anticipate a range of possible future outcomes?

Profit and loss forecasts for various potential scenarios—I counsel modeling three scenarios, including a normal ‘steady state,’ a worst-case ‘crash and burn’ scenario, and a best-case ‘moon shot’ scenario—which should be critical preparedness steps for every advisory business, regardless of firm size.

The steady-state projection is based on your compounded annual growth rate (CAGR) over the past three years. Then, the same analysis will be conducted using a ‘crash and burn’ growth rate (2008 will serve as a benchmark for what a worst-case scenario looks like) and an optimistic exponential growth scenario.

Together, these three will provide the foundation for a well-structured financial model that’s focused on net new money – a model that will help your business:

• Make more informed decisions by projecting revenues, costs, cash flow, and profitability, as well as highlighting potential opportunities and challenges earlier in the planning process.

• Determine how much working capital will be needed to sustain and/or expand the business.

• Assess how changes in key assumptions (e.g., market size, pricing, costs, etc.) may impact your financial outcomes, allowing you to identify risks and make contingency plans.

• Provide essential capacity guidance on which roles to hire for, when to hire those individuals, and when to make strategic investments to fuel growth.

• Identify benchmarks for measuring future performance, compare actual results against the model’s projections, and make adjustments as needed.

• Enhance the credibility of your business plan for investors and stakeholders by building growth projections based on specific data.

Whether you focus on budgeting, capacity planning, investment analysis, or valuation, the following five considerations are crucial for generating reliable and insightful financial models.

1. Assumptions and Input Quality

• • Rather than relying on a single source, use a mix of historical data, market research, and industry benchmarks when formulating your assumptions
  • Avoid being overly optimistic or pessimistic; your assumptions should reflect realistic expectations and conditions
  • Document all key assumptions and sources to aid in gaining stakeholder adoption
  • Regularly update and validate data to avoid creeping inaccuracy in your projections
  • Conduct sensitivity analysis to understand better how changes in assumptions will impact outcomes and help identify potential risks

2. Model Structure and Design

• • To make your model more straightforward to navigate and update, design it modularly (e.g., in your business plan financial model, create separate tabs for the income statement, balance sheet, and cash flow statement, as well as an input tab that allows for a clear linkage between them.) This removes the complexity and simplifies the way to adjust the inputs to your model.
  • Use clear labels, headings, and consistent formatting so users can better understand the model’s structure and follow the calculations
  • Rather than hardcoding numbers, rely on cell references and formulas whenever possible to enhance flexibility and reduce errors
  • Make sure that inputs are dynamically linked to outputs so that any assumption changes will automatically update related calculations

3. Scenario Analysis

• • Establish a base case scenario with the most likely assumptions based on your most recent 3-year CAGR to serve as the primary reference for analysis
  • Develop best and worst-case scenarios to assess extreme potential outcomes and help identify key opportunities and critical risks
  • Create a structure that allows easy switching between scenarios so you can quickly evaluate different strategies and decisions
  • Test the model’s sensitivity to key variables (e.g., different interest rates, cost structures and market conditions) to understand how each scenario impacts short- and long-term returns
  • If you are investing in your business, establish a "pull the plug scenario" to determine the point at which the investment is no longer viable. Set predefined markers in advance to guide your decision-making, allowing you to act without emotion when it's time to terminate or move on.

4. Financial Statement Integration

• • Ensure revenue and expense projections are consistent with any assumptions made in other parts of the model
  • Link balance sheet items such as accounts receivable, inventory, and accounts payable to the income statement and cash flow assumptions
  • Ensure that cash flow projections align with income statement and balance sheet changes, reflecting the true cash position
  • Regularly validate that the balance sheet balances, and reconcile any differences to ensure model accuracy and integrity
  • Reconcile cash flow statements with operating, investing, and financing activities to verify that all cash movements are accounted for
  • Integrate the lines of credit when it comes to cash flow projects. Far too often, we see advisory firms forget about the payback/borrowing on this when they are projecting their profit distributions

5. Model Review and Testing

• • Subject the model to stress testing by applying extreme conditions to assess its resilience and identify potential weaknesses
  • Validate the model against historical data to check for accuracy and reliability; and compare model outputs with actual financial performance to ensure alignment
  • Have the model reviewed by colleagues or experts to identify errors, questionable assumptions, or areas for improvement
  • Thoroughly document the model’s purpose, structure, assumptions, and methodologies to provide full transparency and simplify future updates/audits

Effective financial modeling requires careful consideration of assumptions, structure, scenario analysis, integration, and testing. By adhering to these principles, you and your team can build models that provide invaluable insights, support more informed strategic decisions, and stand up to careful scrutiny. They’ll provide you with a solid foundation for better understanding the business's financial dynamics, planning for various scenarios, securing funding, and monitoring performance—ultimately leading to a more strategic and resilient business plan. Remember, though, financial modeling and forecasting is a very specific skill set, and it’s more than understanding how Excel works or even being able to read financial statements. Many professional finance and accounting professionals have never ventured into financial planning and analysis (FP&A). Seek professionals with unique expertise in this area to help you and your firm.

Coaching Questions from this Article

1. Consider the areas of your business (strategies and actions) that impact organic growth the most. Which are most critical to your success, and what measures can you use to track continual improvement?
2. When comparing your future vision to your present business, what opportunities and challenges do you see on the horizon, and what planning steps can you take to better prepare for them?
3. Based on your most aggressive growth model, what changes would you need to make for your strategic hiring plan to meet those projections?
4. Once you’ve identified the most critical measures to track your firm’s continued growth and success, who on your team will be responsible for measuring progress and how frequently adjustments will be implemented?
5. When investing in your own business or acquiring another firm, how will you evaluate opportunities with very different financial benefits (e.g., revenue contribution, equity growth, long-term partnerships, turnover avoidance, etc.)?

¹ “From tailwinds to crosscurrents: Resilient growth in wealth management,” McKinsey & Company, January 25, 2023