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Hosted by Financial Advisor Coach, Ray Sclafani, "Building The Billion Dollar Business" is the ultimate podcast for financial advisors seeking to elevate their practice. Each episode features deep dives into actionable advice and exclusive interviews with top professionals in the financial services industry. Tune in to unlock your potential and build a successful, enduring financial advisory practice.
Ray Sclafani (00:00.366)
Welcome to Building the Billion Dollar Business, the podcast where we dive deep into the strategies, insights and stories behind the world's most successful financial advisors and introduce content and actionable ideas to fuel your growth. Together, we'll unlock the methods, tactics and mindset shifts that set the top 1 % apart from the rest. I'm Ray Sclafani and I'll be your host.
The RIA growth illusion. How to create a financial model that drives organic growth. Well, for the 10 years between 2012 and 2021, wealth management firms experienced a record $30 trillion surge in asset center management from 20 .6 trillion to 50 .4 trillion. Yet during that same decade, global markets experienced an unprecedented 14 % average annual rate of growth.
How did these two data points connect? Well, according to a McKinsey and Company study conducted in 2023, their analysis revealed that nearly three quarters, 70 % of industry -wide asset growth resulted from, this, capital market performance. And much of the remaining 30 % was due to acquisitive growth. So in other words, much of the organic growth many firms believe they've achieved over the past decade is more smoke than substance.
Day in and day out, you counsel clients on the critical importance of having a financial plan. Yet how much time do we devote to conducting thoughtful financial modeling for our own businesses, understanding CAGR, understanding growth rates, and really making a serious decision to grow organically? Have you ever sat down and modeled various what -if scenarios that anticipate a range of possible future outcomes?
My take is that the reason why most of the RIA channel is actually not growing is that they haven't done proper forecasting and anticipating what growth lies ahead and how to scale up and prepare for that growth. Profit and lost forecasts will actually help you do this, but you gotta have various potential scenarios. I counsel financial advisors to model three separate scenarios, include a normal 'steady state' scenario, a worst case
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'crash and burn' scenario and a best case 'moon shot' scenario. Each of these will be critical preparedness steps for every advisory business, regardless of firm size. I know you may be thinking, well, this is what private equity firms do or only billion dollar plus firms do. But if your expectation is to grow and scale a multi -billion dollar wealth advising business, you've got to want to do this. The steady state projection is based upon your three year
compounded annual growth rate, the CAGR. Then the same analysis is conducted with a crash and burn scenario. I like using the 2008. That's a good benchmark for what worst case scenario looks like. And then there's the optimistic exponential growth scenario. It's the moonshot. Well, together, these three will provide the foundation for a well -structured financial model that's focused on net new money, revenue growth, profit growth. Well, it's a model that's going to help your business in six ways.
You'll make more informed decisions by projecting revenues, costs, cashflow, and profitability, as well as highlighting potential opportunities and challenges earlier in the planning process. This will help you determine how much working capital will be needed to sustain and or expand the business. You'll also know how to assess changes and key assumptions like market size, pricing, operating costs, human capital costs, and how they may impact your financial outcomes.
which will allow you to identify the right risks and make contingency plans. You'll also know how to provide essential capacity guidance on which roles to hire for. After all, on that P &L, what is the greatest line item of expense? When you're hiring individuals, making strategic investments that are gonna fuel growth, you've got to understand that capacity need, especially if you plan on fueling growth. You'll know how to identify benchmarks for measuring future performance.
and then how to compare the actual results against your model's projections. And that makes adjusting really easy. And lastly, you'll enhance the credibility of your plan. So investors and stakeholders all of a sudden have greater confidence in your plan because there's very specific data with which it's based. So whether you focus on budgeting, capacity planning, investment analysis, or valuation, the following five considerations are crucial for generating reliable,
Ray Sclafani (04:50.912)
and insightful financial models. You know, this RIA growth illusion really catches my attention and the idea that most firms want to grow the greatest asset perhaps that sits on your personal balance sheet. Growth is a key driver to the expansion of enterprise value. And with multiple stakeholders, multiple shareholders, now's the time to really get this financial model right because it will provide and illuminate
insights that you might not know otherwise. So let me run through these five considerations. Let me give you some bullet points that I think will help make your analysis better. And then we'll wrap up. First, let's consider assumptions and input quality. So 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.
These assumptions should reflect realistic expectations and conditions. Document all your key assumptions and sources that'll aid in gaining stakeholder adoption and confidence in your model. Be sure to regularly update and validate the data so you avoid inaccuracy in your projections, which from time to time can creep in and conduct a sensitivity analysis to understand better how changes in your assumptions will impact your outcomes and help you identify potential risks.
Second, you've got to model structure and design. To make your model more straightforward to navigate and update, you've got to design it in a modular fashion. So for example, in your business plan financial model, create separate tabs for an income statement, balance sheet, and cashflow statement, as well as an input tab that allows for clear linkage between each of these. This will remove the complexity and simplify the way to adjust the inputs to your model.
Use clear labels and clear headings and consistent formatting. This way, anybody that's looking at the model can better understand how your structure looks and how you follow your calculations. Rather than hard coding the numbers, rely on cell references and formulas whenever possible. That'll enhance flexibility and reduce errors. Lastly, make sure that inputs are dynamically linked to outputs. So any assumption changes you make,
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automatically update the related calculations. The third, I talked about this earlier in this episode, but scenario analysis is essential. Establish the base case with the most likely assumptions based upon your most recent three -year CAGR. That'll serve as the primary reference point for your analysis. I often notice that most teams are built to produce exactly the kind of revenue and results that they're currently built for. Rarely do you see
over investment, excess capacity, excess capability. So using the recent three -year CAGR builds this base case. This is the steady state. Next, develop a best and worst case. I like calling it moonshot and crash and burn. This helps assess extreme outcomes and identifies key opportunities and critical risks on either end of the spectrum.
Create a structure that allows easy switching between the scenarios so you can quickly evaluate different strategies and decisions. You want to test the model sensitivity to key variables such as different interest rates, different cost structures, market conditions. This way you'll better understand how each scenario impacts both short and long -term results. If you're investing in your business, establish a pull the plug scenario to determine the point at which
the investments no longer viable. I was speaking with a fractional CEO when I was writing this article and he said something really clear to me. He said, you got to set predefined markers in advance. This way you're guiding your decision -making, allowing you to act without emotion when it's time to terminate or move on. Especially if you're in the M&A A game, if you're merging other businesses and acquiring other businesses or doing an aqua hire where you're looking for talent.
in an investment and maybe not all the clients and the revenue. All of these will help you determine how far into an investment you should make. Number four, financial statement integration. You absolutely need to ensure that revenue and expense projections are consistent with any assumptions made in the other parts of the model. Link your balance sheet items such as accounts receivable and inventory and accounts payable to the income statement and cash flow assumptions.
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ensure that cash flow projections align with the income statement and balance sheet changes, reflecting the true cash position. You know, the cash can be lumpy from time to time, especially in that fee on AUM quarterly payment structure. So cash position really matters. Regularly validate that the balance sheet balances and reconcile any differences to ensure model accuracy and integrity. Reconcile the cash flow statements with operating, investing and financing activities
so that you can verify all cash movements are accounted for and integrate the lines of credit when it comes to cashflow projections. Far too often we see advisory firms forget about the payback, the borrowing on this when they're projecting their profit distributions. And fifth, you want to model review and testing. Subject the model to stress testing. Apply extreme conditions to assess its resilience
and identify those weaknesses. Validate your model against historical data, check for accuracy and reliability, compare model outputs with actual financial performance. This is going to assure alignment between what's actually happening and what your model suggested. Each time you do this quarter after quarter, year over year, the rigor and building this financial performance model and building this learning inside your organization.
will help build a better, more durable business. Have the model reviewed by colleagues or experts to identify errors, questionable assumptions or areas for improvement. And lastly, thoroughly document the model's purpose, its structure, its assumptions, your methodologies to provide full transparency and simplify future updates and audits. We didn't talk about audited financials, but perhaps you're considering a private equity partner or a long life capital partner.
Perhaps you're a serial aggregator or somebody that's looking to sell up into a larger firm. There are certain circumstances where a professional auditing firm coming in to look at your books makes a whole lot of sense. Effective financial modeling requires careful consideration of all your assumptions, your structure, your scenario analysis, your integration and your testing. So by adhering to these principles, you and your team can and will build models that provide invaluable insights.
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support more informed strategic decisions and stand up to careful scrutiny. In fact, it's this reason why I think most RIA firms are now thinking about organic growth in new and different ways. As they build out these models, the opportunity for success is really bright. We're on the precipice of one of the largest wealth transfers in recorded history in the United States. There's never been a better time to be a financial advisor.
with more than 300 million Americans and about 150 ,000 advisors last year was the very first time we saw a crossover with more advisors leaving the business than joining the profession. There's been more CFP graduates and more universities offering the CFP program than ever before. So my take is now's a really good time to build out these models and stress test them. Think moonshot, think what's ahead and then
back into that realistic expectation, build the capacity, the capability and access to capital. After all, with a solid foundation for better understanding your business's financial dynamics and planning ahead for various scenarios, you'll be better able to secure funding, monitor performance and make adjustments along the way. All of this leads to a more strategic and resilient business plan. Remember though, financial modeling and forecasting is a very specific skill set.
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. That's the FP &A. So seek out professionals with unique expertise in this area to help you and your firm. With each article, there are a series of Coaching questions- these are designed for you and your leadership team to answer together. Answers to these questions will build a bespoke
and relevant set of solutions for you and your team. So first, consider the areas of your business that impact organic growth the most. What are your strategies, tactics and actions? Which are the most critical to your success? And what measures can you use to track continual improvement? Second, 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 right now?
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to better prepare for them. Third, based upon your most aggressive growth model, this is the moonshot model. What changes would you need to make right now to your strategic hiring plan to meet those projections? Most advisors don't have the capacity or the capability to actually hit that aggressive growth model. Some firms are hiring more lead advisors and building training programs internally because they know the opportunity is ahead. Consider thinking out of the box here.
talent is key to the long -term success and meeting those projections. Fourth, 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 not only building out that plan, leading that plan, measuring the progress, and helping to make adjustments. More firms are hiring chief business development officers or chief growth officers, somebody to help lead this organic growth initiative.
And fifth, when investing in your own business or acquiring another firm, how will you elevate opportunities with very different financial benefits, such as revenue contribution, turnover, equity growth, even long -term partnerships? Well, thanks for tuning in. And that's a wrap. Until next time, this is Ray Sclafani Keep building, growing, and striving for greatness. Together, we'll redefine what's possible in the world of wealth management. Be sure to check back for our latest episode and article.