Operational and financial control

Profit

Profit (before tax) is the difference between the total fees earned and the total costs and expenses incurred over the budget period. It provides for:

●a profit-share or bonus to the owners, partners or other employees of the consulting firm;

●establishing security reserves;

●increasing the working capital;

●financing capital expenses;

●paying a profit (income) tax.

As shown in table 33.2, in most cases the profit margin would be between 10 and 25 per cent of total income. The actual figure will depend on such factors as the possibility of charging fees that provide for an adequate profit, the ability to reduce and control expenses, and the firm’s need to generate resources for further expansion of its services or for other purposes mentioned above.

33.2 Performance monitoring

The monitoring of operational and financial performance is an essential, yet often underestimated, management function in consulting firms. The purpose is not to produce statistics for their own sake, but systematically to collect and evaluate key information likely to reveal negative trends (from which will spring the need for action to redress the situation) or positive trends (which may need to be reinforced so that any opportunities disclosed are not missed).

Performance monitoring aims at immediate improvements first of all, but its strategic implications should not be overlooked. It helps to reveal changes and trends that will affect the consulting firm in the long run, such as major shifts in demand for certain kinds of service, or the increasing cost of selling services to certain markets. Adjustments to the firm’s strategy can thus be based on hard data rather than guesses and estimates.

Comparing and benchmarking

It is impossible to assess performance without making comparisons: superior or substandard performance can be identified and assessed only with reference to some other performance. Consultants use comparisons and benchmarking extensively when working with clients, and they should not hesitate to apply them to their own operation.

Comparing results achieved with planned or projected targets can be revealing, provided that the targets were based on thorough analysis and realistic goalsetting, and not just on guesswork. The main documents to which this comparison refers in performance monitoring are the annual workplan and operating budget.

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Comparing current and past performance can show trends in performance, as well as changes in factors affecting it.

Comparing performance with other consultants can be most instructive. This can be done in various ways:

–Consultants who are business friends can exchange and compare data informally, as colleagues who want to learn from each other.

–There can be a formal interfirm comparison scheme, run by a consultants’ association or another agency. Under such a scheme, key data are collected, tabulated and distributed to participating consulting units on a regular basis, without revealing the identity of the units.

–Performance achieved by a specific consulting firm can be compared with sectoral standards. Such sectoral standards would reflect “good practice”, i.e. the experience of consulting firms whose management is considered competent and performance adequate. Here again, such standards can be developed as benchmarks by an association for the benefit of its members. This book refers to a number of ratios collected from consulting firms and their associations. These operating ratios can be regarded as a form of standard.

In making comparisons, it is essential to determine the causes of superior or substandard performance: this may result from excellent or poor management of operations and assignment execution, but also from an unforeseen change in the business environment over which the consulting firm has little control.

Both data from other firms and any sector standards or averages have to be used cautiously. The situation and possibilities of your firm may be very different and so may be your objectives. While it is extremely useful to know how others perform, superficial and hasty conclusions should not be drawn from the data without comparing resources, conditions and strategies.

Key monthly controls

Operational controls have to be established and examined relatively frequently to permit action before it is too late. In practice, this will be monthly in most cases. This explains why the operating workplan and budget described above are prepared with a monthly breakdown of most data. Any deviation from the consulting unit’s standards, or any undesirable trend, should be detected by management. Management will have to consider whether prompt corrective action is desirable and feasible, or whether changes in short-term indicators are signals of longer-term shifts in the market, the profession or the firm itself. Box 33.2 can be of help in establishing a list of controls that suits a particular consulting firm.

Annual controls

Not all ratios lend themselves to short-term monitoring and action, so not all need to be presented every month. A dropping backlog of work or falling income

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Box 33.2 Monthly controls: a checklist

(1)Forward workload (backlog)

Most important; ideally it should be around three months and should not drop below one-and-a-half months; if it is too high, clients are kept waiting for too long.

(2)Number of client visits (meetings, surveys) to number of assignments negotiated

Indicative of the effectiveness of promotional work. An alternative ratio is volume of new business negotiated per client visit (meeting, survey), or number of marketing days required to get an assignment or to obtain a certain volume of new business (say US$100,000). This is more precise if assignments vary greatly in extent.

(3)Actual and budgeted utilization of total time

Can be computed for all consulting staff or by categories, e.g. for operating consultants, supervisors, partners and officers; shows not only whether the firm has enough to do, but also whether work is properly scheduled and organized for smooth delivery.

(4)Cumulative actual fee-earning days against planned fee-earning days

Similar use as previous ratio.

(5)Actual and budgeted fee rate

Can be computed for all consulting staff or by categories of consultant; helps to assess whether the firm is in a position to apply optimum fees and gives guidance in using the staff in accordance with their technical and incomegenerating ability.

(6)Fees earned against fees budgeted (monthly and cumulative)

Synthetic indicator of actual programme delivery rate in financial terms.

(7)Fees earned against expenses (monthly and cumulative)

Synthetic indicator of short-term performance in financial terms; can provide early warning of excessive expenses and cash shortages.

(8)Expenses incurred against expenses budgeted (in total and by expense budget lines; monthly and cumulative)

Permits detailed control by expense lines, providing suggestions for specific expense-cutting measures and for adjustments of budgets owing to price and other changes outside the consultant’s control.

(9) Monthly billing against monthly fees earned

Shows whether the firm is properly organized to process work records and bill the clients as soon as records become available.

(10) Number of months of outstanding fees

Shows whether fees are collected within normal time limits (four to six weeks); an alternative ratio is outstanding fees as percentage of total (annual) income.

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require immediate management attention, and these data are therefore needed monthly. The basic staff structure cannot be changed by short-term measures, and an analysis of relevant information once or twice a year may be enough.

An annual performance review, or audit, would examine the data collected on a monthly basis, plus other financial and non-financial data, such as:

●growth rate of business;

●gross and/or net profits compared with total income;

●profit per partner and per consultant employed;

●volume of work sold per consultant engaged in the marketing services;

●ratios indicating the structure and turnover of consulting and other staff (various categories);

●ratios showing time utilization and time allocation to various services and activities, including the structure of non-billable time;

●expense and cost structure (relative magnitude of various expense lines);

●marketing and business development costs;

●fee rates;

●partner, consultant and other staff compensation, including compensation through share options;

●non-collectable fees (bad debts) and other losses as part of total income.

It is often useful to analyse various financial ratios which can be calculated from the annual financial statements. However, before doing this, it is necessary to consider whether the ratios are as meaningful in consulting as in manufacturing industry and other sectors (owing to factors such as the relatively small volume and role of fixed assets, etc.). In addition, trends may be analysed by comparing data over five to ten years.

Here again, analysis should reveal causes and suggest a focus for future action. Increased income can be the result of better performance, but also of price adjustments to reflect inflation, while real performance in non-financial terms has not changed or has deteriorated.

A general profit model for professional firms was described in section 27.3. The model can be used for a firm’s annual performance reviews, for example as recommended by the Association of Management Consulting Firms (AMCF) in its annual surveys of consulting firms.1 The model provides both for a synthetic view of profitability (profit per partner) and for more analytical information on key factors that have affected the profit per partner ratio. The expanded model is reproduced in figure 33.1.

Organizational level of performance monitoring

The management of the consulting firm will be interested in knowing and analysing all key factors, both monthly and annual. As a rule, operating and financial performance ratios are reviewed at regular management meetings. If

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