Quick Tips for Developing Profitability by Client and Forecast Models

Michael Lamm

Back in January we released a report titled, “Survive Today and Thrive Tomorrow: 8 Tactics from Successful ARM Companies” where our team touched upon 8 tactics to help address today’s challengesnwhile positioning your business for long-term growth. Two particular areas that are near and dear to my heart, as an M&A advisor, is the importance of creating and maintaining forecasts and having the ability to track profitability by client.

These items are important financial models whether you have 5 or 1000 employees to help manage and operate your service business as efficiently and with the most business intelligence as possible; however, these models are not developed overnight. Before trying to tackle creating these models, we suggest taking a step back and assessing whether you have adequate resources and financial processes in place to accurately develop them. There is no point in developing these models if you cannot rely on the data used to create them.

Here are a few tips before you start creating these models:

1. Finance and Accounting Oversight – Start at the top – who is overseeing the finance and accounting (F&A) functions of your business? Who supports that person in pulling financial information like this together? We find that for small to mid-size ARM firms the owner may be playing a dual role where they are ultimately responsible for F&A as well as other core functions for the business such as sales and/or operations. Like anything else, the owner(s) needs to determine, based on the company’s financial resources, whether hiring a controller or a CFO (for larger companies) as well as a support staff would be appropriate. We find that firms who have a dedicated resource overseeing the F&A functions for the company operate more efficiently and allow the owner to focus on what he/she does best, driving sales and/operational performance. This individual should be the one spearheading the development of the profitability by client and forecasting models with insight from you (the owner) and management.

2. Data Quality from your Collection Software Platform – Once you determine who is going to spearhead the development of these models, take a hard look at your software platform. Whether you have an off-the shelf platform or a proprietary system you have developed, the data that is housed in your system feed the F&A functions to your business. It is important to determine how the data is being pulled and segmented and ultimately how accurate it is. We always suggest doing a sampling of the collection data that is tying into your F&A reports to assure that the data is clean and corresponds to the data you are pulling from the F&A system i.e. QuickBooks. A lot of times the main driver for financial reporting problems is a result of collection data from your software platform that is being entered incorrectly or miscategorized.

3. Profitability by Client Model – Once you have appropriately assessed the data quality from your software platform and accounting system, the art of developing this model can start to take shape. Think about the inputs required such as how that client is serviced throughout your organization and how you will be able to create a monthly P&L statement that is able to show you and your team revenue (net fees), fixed and variable expenses associated with that client as well as an appropriate corporate allocation. Many ARM firms run blended programs where it gets complicated on how to allocate staff resources to a client that may be servicing 3 others. This model becomes an important tool internally to determine how you will get a client to profitability or determine the time has come to shed them. This model should be developed so you can track all of your key client relationships on a monthly basis.

4. Forecasting (Top Down Approach) – It is never easy especially for a contingency based ARM service provider to forecast out beyond the next 30 days but it can be done. The first step would be to take the last 3 years of the company financials and client data and determine the trends that have existed with your business i.e. pull out any one-time first party projects or expenses that occurred so they do not impact your model. We would typically start with projecting out monthly revenue by existing clients first and then break out anticipated revenue from your sales pipeline (consider what assumptions with probabilities you want to make with the pipeline). Be sure to pull out clients that were recently lost and put them into a separate bucket if you retained the paying accounts so those future revenues can be tracked as a separate line item. Once you have a good picture of the potential revenue, tackle the expense categories from the prior year and determine how you expect them to fluctuate with increases/decreases in client business volumes. Additionally, you will need to account for any anticipated expenses that will run through the P&L i.e. opening up of a new facility, making a hire of a new sales or operations person, etc. It is always helpful to list out your revenue and expense assumptions for each year that you are forecasting to see on paper how they tie to the forecast.

Don’t expect this “model” process to happen quickly. It will take some time to inspect whether you have the right data you need to develop these financial models. If you break up the process into a series of tasks, getting to functional models that can be used “real time” in your organization will help you immensely make critical business decisions and give you the intelligence you need to support them.

What has your experience been in developing these models? What have you done to gather the data? What challenges have you had with tracking profitability by client and the development of forecasts? Have you been able to use your collection software platform customized reports modules to help you assemble this information?

Comments/questions are always welcome.

Michael D. Lamm advises owners on their growth and exit strategies for Kaulkin Ginsberg’s Strategic Advisory team. Michael can be reached directly from Kaulkin Ginsberg’s Philadelphia office at 240-499-3808 or by email. You can also read his blogs, follow him on Twitter, or network with Michael.