Observing ratios in comparison with benchmarks and trends is interesting, but these numbers become even more revealing when you do a financial-impact analysis. The impact analysis translates the variance into a dollar amount. When you understand the magnitude of the problem, you’re better able to focus on the solution. It may be tempting to downplay the problem when the ratio is off from the benchmark by only a fraction or a small percentage.

In reality, a 1 percent variance can have a significant effect on the financial performance of your practice. One percent of a million dollars, for example, is real money.To measure that financial impact, you must identify your target. This may be a benchmark derived from the FPA Financial Performance Study, or your firm’s best year, or even an arbitrary number.

The point is to compare your firm’s number with the number to which you aspire. For example, let’s say that your practice’s revenue is $1,000,000 and your target operating profit margin is 25 percent (as determined by the industry benchmark), thus$1,000,000 × .25 = $250,000. Your financial statements indicate that your operating profit margin is only$100,000, or 10 percent of revenues. Based on the industry benchmark, that means you’re $150,000 short of the amount appropriate for your firm. So how do you use this information? Now that you’ve uncovered the magnitude of the problem, you can go back to your analysis and focus on the causes of low profitability —namely, a low gross profit margin, poor expense control, or insufficient revenue volume to support your overhead. What do you look at first? Improving profitability requires following a logical, four-step process: 1. Cut costs. 2. Improve gross profit margin. 3. Increase volume. 4. Raise prices (if you have discretion to do so). The most immediate way to attack low profitability is to determine which costs you can eliminate. This may mean making some hard choices, such as laying off staff, subletting space in your office, or imposing restrictions on purchases. Advisers often find these choices difficult to make because they assume that such cuts will seriously damage the business. But let’s look at things in perspective: if you’re not making enough to get the firm on the road to financial independence—plus provide a sufficient return to invest in your practice so that you can serve clients better—then you’ve already begun to damage your business. What steps are you going to take to make things right? Is it easier to cut costs or to increase revenues? Is it easier to adjust pricing or to be more selective about which clients you take on? Is it easier to train staff to be more effective or to lay them off? When it adds up to a$150,000 problem in a \$1,000,000 practice, the steps required are probably a combination of all of these and more.

Obviously, the problem is even more acute in small practices because there are probably not as many areas to cut costs and still serve clients well. For many small practices, recognizing this dilemma becomes the catalyst for their decision to merge with another firm.