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Estimating the lifetime value (LTV) of clients, while not common practice among most advisors, can provide useful insights into clients’ profitability. You might be tempted to assume that your largest clients are the most profitable, but this is not necessarily the case, says George Hartman, CEO of Market Logics Inc. in Toronto.

Estimating LTV is not an exact science and can be complex. Basically, it involves estimating the amount of revenue you expect to earn from each client and then subtracting the estimated cost of servicing him or her over the assumed length of time he or she is expected to remain with your practice.

To arrive at a more accurate figure, you must also take into consideration that clients may add assets to their portfolios over time, resulting in higher revenue, and also may provide referrals, who in turn might provide additional referrals. The revenue earned from each referral must be attributed to the primary client, thereby increasing his or her LTV. Hartman refers to this concept as the “multiplier effect” when estimating LTV.

When you consider that the main source of new clients for most advisors is referrals, the relative importance of estimating LTV increases.

Here are some suggested steps for estimating the LTV of your clients:

> Estimate revenue from clients
Hartman recommends estimating the stream of revenue you expect to earn from a client over a defined period — for example, 10 years — based on the assets you manage for them. “You have to look beyond first year’s revenue,” he says.

For example, if a client generates $5,000 of revenue in Year 1, their lifetime revenue would be $50,000 over 10 years. You may also wish to add an estimate for additional contributions over that period based on your knowledge of the client’s personal situation.

> Estimate revenue from referrals
“Review your records to determine referrals made by clients,” Hartman says. Include “first tier” referrals, made by primary clients, as well as “second tier” referrals, made by referred clients.

Next, determine how much revenue you generate from both tiers of clients. This revenue should be added to that generated from the primary client to arrive at a more accurate estimate of lifetime revenue.

“You don’t have to be precise,” Hartman says. “All you want is a good estimate.”

> Estimate costs
The final step in estimating the LTV of clients is to subtract the cost of serving clients from the value of revenue earned over their lifetime.

The biggest cost, Hartman says, is usually your time. He suggests that you take the gross revenue earned by your practice over a specified period and divide it by the number of hours you worked over that period to arrive at an estimated hourly rate. Then, calculate how many hours you spend with each client.

So, if your hourly rate turns out to be $500 and you have four one-hour reviews with a client each year, the cost of your time for that client would be $2,000.

In a similar manner, estimate the cost of your staff in serving clients.

“Look at services provided to each tier of clients,” Hartman says, as your Tier 1 clients will typically get a higher level of service, which costs more.

You should also attribute overhead costs, such as rent, equipment and office supplies to each client by dividing your total overhead costs by the number of clients you have.

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