March 30, 2011

Practical Perspectives On Financial Management: Lessons From Leading Firms

By Maureen Broderick, Founder and CEO, Broderick & Company

On the surface, professional services seem like simple businesses to manage financially. It's mostly a time and materials business driven by rates, revenue, utilization, realization, and expenses. But there are nuances that make it challenging. In the short-term project-based professional service firm (PSF) environment, it is almost impossible for many firm leaders to see beyond the window of a few months, which makes revenue forecasting a distinct challenge.

The fluid and uncertain nature of the market makes it difficult to determine where to place investments in practices, geographies and people. Decisions must be made quickly to capitalize on opportunities, which is not easy in a PSF governance environment where partners and equity owners must all weigh in on key financial decisions.

And finally, most professionals don't like what they perceive to be tedious, bureaucratic processes — like timekeeping, billings and collections — that keep them from focusing on their clients. One CFO admitted that getting partners to send out their bills or even worse, call clients to collect if they don't pay, is one of his biggest problems.

So what do the best firms do? In the course of our research, a number of common best practices of disciplined financial management emerged:

• Strong planning and budgeting The top firms have a clearly articulated financial strategy that establishes revenue and earnings goals which reinforce their strategic business plan. Financial planning and budgeting is done in conjunction with annual operating plans and is a collaborative process between the management team and business unit leaders.
• Rigorous tracking and reporting Leaders of the best firms have very thorough, timely reports of the relevant metrics needed to run their businesses efficiently and effectively. Many have 24/7 access to executive dashboards providing an up-to-the-minute picture of the financial health of the firm.
• Careful management of cash flow The most successful firms have effective and timely billing functions and closely manage cash flow from collections and working capital. As one CEO told us, "If a firm has cash, it is a well run place. If they don't, it isn't." Strong firms are adequately capitalized and maintain close banking relationships.
• Forward looking vs. purely historical Savvy firm leaders use a combination of both lagging and leading indicators to manage the business. Traditional metrics such as revenue, profitability, utilization and realization are paired with trend spotting data such as talent retention, declining billings, client satisfaction, and sales pipeline to spot early warning signs that the firm may be heading toward financial trouble.
• Transparency to partners Firmwide financial goals and results are shared with partners in most of the PSFs we studied. Firm leaders believe that a transparent open reporting environment is important to build the ownership mentality and encourages participation and accountability from the partnership team.
• Accountability The best PSFs hold business unit leaders accountable for the financial performance of their practice areas. Financial goals have clearly established metrics and performance against plan is closely monitored and tied to compensation.
• Investment in people and tools Even the smallest firms in our study have made investments in experienced financial professionals — either full or part-time or outsourced — to work collaboratively with partners to manage planning, budgeting, tracking and measurement. The best PSFs use sophisticated analytical tools that provide timely, action-oriented management information.

Metrics to Monitor the Business

In assessing the financial health of the organization, astute firm leaders at the top PSFs look at both lagging and leading indicators. Lagging indicators are those metrics that measure the results of financial performance that has already occurred — revenue, utilization, realization, costs, etc. Most firms studied use a fairly standard set of metrics to track performance. Ninety-three percent of respondents place revenue at the top of the list of key metrics followed by profitability, utilization, realization, costs, margins, pricing, leverage and performance efficiency.

Firm managers sort and analyze each of these metrics by a variety of categories, typically: for the firm overall; by partner and professional; by business and geographic units; and by client and engagement. The weight that leaders place on each metric varies by type of business. For example, in highly leveraged models with many people working for one partner, utilization is critical. For less leveraged higher-value types of services, revenue per professional is important to watch.

Early Warning Signs

While these metrics are critical to running a business, they are only part of the equation. Leading indicators, like declining revenue growth per client or professional turnover, facilitate the ability to forecast future outcomes to make adjustments or change direction before there is a serious problem, or take advantage of an opportunity emerging on the horizon. As one managing partner said, "It doesn't do me much good to get a report in mid July that tells me we had capacity the second week of June."

Firm leaders described a variety of red flags or early warning signs that they monitor to stay on top of their firm's financial health. Most of these indicators coalesce around four components of the business:

• Clients and new business Are billings, the proposal pipeline and the backlog of work declining? Are clients happy, paying their bills and buying more services?
• The partnership Are partners united in firm vision and values? Are they retaining their clients, growing their practices with profitable business, and developing intellectual capital? Are under-contributing partners terminated?
• Talent Are talented people joining, staying, and enthusiastically adding value to the organization?
• Management Are the cash reserves low or non-existent? Are the numbers steadily declining on all key economic metrics — revenues, profitability, utilization, margins, etc.? Are you unwilling to cut back when demand flattens?

Dennis Nally, Global Chairman of PwC, says that it is important to remember that financial results are only one aspect of firm management. "Our dashboard at PwC is focused on a balanced scorecard approach," says Nally, "it starts with our people strategy — how are we doing in terms of recruitment, turnover and employee satisfaction? Second, we talk about the quality and value of our client work and relationships. And finally, we look at classic financial performance metrics — revenues, cost structure, profitability, margins and so on."

Warning signs of failing financial health
Clients		Partnership		Talent		Management
Declining billings Declining revenue growth per client Declining realization or clients not paying on time Instability in client relationships; declining satisfaction Low backlog of work Fewer proposals in the pipeline Fewer wins higher losses to competitors Little cross-selling High client turnover		Partner departures Lack of consensus among leaders on key strategies leading to inaction Insufficient collaboration in business development and client service across geographical lines Principle glue is financial results Inability to improve or exit under-contributing partners Eclectic collection of practices Decline in intellectual capital development Deferring expenses, artificially accelerating collections Partners have no understanding of financial requirements		Declining satisfaction and enthusiasm per employee surveys Unplanned employee attrition Difficulty attracting top talent; losing to competitors		Low cash position Declining revenues and margins Declining utilization Lack of timely action on negative metrics Potential legal exposures and contract liabilities increasing Poor/unstable relationship with banks Unwillingness to cut back when demand flattens

Maureen Broderick is founder and CEO of Broderick & Company, a consulting firm specializing in strategy, research and training for professional services. Her new book, "The Art of Managing Professional Services" (www.theartofmanagingprofessionalservices.com) was published in November 2010 by Wharton School Publishing. The book is based on over 130 in-depth interviews with leaders of many of the top professional service firms including Burson-Marsteller, Cohn & Wolfe, Edelman, Euro RSCG Life, Fleishman-Hillard, Ketchum, Ogilvy PR Worldwide, Peppercom and Young & Rubicam Brands.