Financial management systems and early warning signs

On the surface, professional services seem like they should be simple businesses to manage, financially. They are mostly time and materials businesses, driven by rates, revenue, utilisation, realisation and expenses. But there are nuances that make it challenging.

In the short-term, project-based professional service firm (PSF), it is almost impossible for leaders to see beyond a few months. This makes revenue forecasting a real 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 capitalise on opportunities, which is not easy in a PSF-governance environment, where partners and equity owners all weigh in on key financial decisions.

And most professionals do not like what they perceive to be tedious, bureaucratic processes – such as timekeeping, billings and collections – that keep them from focusing on their clients. One finance chief relates that getting partners to send out their bills, or call clients to collect if they do not pay, is one of his biggest problems.

Clear strategy
So what do the best firms do? While researching The art of managing professional services through interviews with 130 firm leaders, there emerged seven best practices of disciplined financial management.

The first is strong planning and budgeting. 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.

Second, 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 that provide an up-to-the-minute picture of the firm’s financial health.

The third piece of best practice is careful cash-flow management. The most successful firms have effective and timely billing functions, and closely manage cash flow from collections and working capital.

As one chief executive puts it: ‘If a firm has cash, it is a well-run place. If it doesn’t, it isn’t.’ Strong firms are adequately capitalised and maintain close banking relationships.

Fourth, successful firms use a mixture of forward-looking and historical data. Savvy firm leaders use this combination of lagging and leading indicators to manage the business.

Traditional metrics, such as revenue, profitability, utilisation and realisation, 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.

Best practice number five in most of the PSFs we studied comprises firm-wide financial goals and results being shared with partners. Firm leaders believe a transparent reporting environment is important to build the ownership mentality and encourages participation and accountability from the partnership team.

Accountability is best practice six. 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.

The final theme is investment in people and tools. Even the smallest firms in our study have invested 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.

Red flags
As noted, in assessing the financial health of their organisation, astute firm leaders at the top PSFs look at both lagging and leading indicators. Lagging indicators measure the results of financial performance that has already occurred – revenue, utilisation, realisation, costs and so on.

Most firms we studied use a fairly standard set of metrics to track performance: 93% of respondents place revenue at the top of the list of key metrics, followed by profitability, utilisation, realisation, costs, margins, pricing, leverage and performance efficiency.

Firm managers sort and analyse each of these 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 leaders place on each metric varies by type of business. For example, in highly leveraged models, with many people working for one partner, utilisation is critical. For less leveraged, higher-value types of service, revenue per professional is important to watch.

While these metrics are critical to running a business, they are only part of the equation. Leading indicators – such as 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 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 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 organisation?
• Management: are the cash reserves low or non-existent? Are the numbers steadily declining on all key economic metrics – revenues, profitability, utilisation, margins, etc.? Are you unwilling to cut back when demand flattens?

Dennis Nally, global chairman of PwC, concludes it is important to remember financial results are only one aspect of firm management. ‘Our dashboard at PwC is focused on a balanced scorecard approach,’ he explains. ‘It starts with our people strategy – how are we doing in terms of recruitment, turnover and employee satisfaction?

'Secondly, 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.’

Maureen Broderick is the author of The art of managing professional services: insights from leaders of the world’s top firms, published by Wharton School Publishing, and CEO of consulting firm Broderick & Company