Most agency owners struggle with cash flow, and yet cash flow is not really the issue. Instead, cash flow is a symptom of an underlying issue with the agency’s financial system. There are a whole host of things that can cause cash flow problems.
5 Little-Known Reasons for Cash Flow Problems
1. Collections & Accounts Receivable
Most agencies have accounts receivable, which can lead to cash flow issues when a client won’t pay what they owe you for work performed. There are a few tips for managing the process of collecting payments from clients.
- Get rid of accounts receivable. Is there a way you can charge customers either upfront or throughout the process for the service you are providing? Most business owners are scared of making the switch, and there may be limitations in rolling it out to all your clients. Why not start by having all new clients pay in advance?
- Find a champion of accounts receivable. Whether you go with a collections agency or name someone internally, you need a point person who will lead up the charge in getting clients to pay.
- Retain something of value. Always make sure to retain something of value to that client until you get the final payment. For many creative agencies, this would include creative assets, website, or final deliverable.
2. Emotional Decision Making
Business is a very emotional thing, and there are certain decisions to be made based on a gut feeling. But it can also get business owners in trouble, especially when it comes to cash flow. If a business owner is making a purchase or hiring based on emotion, without fully understanding the cash flow of the business, it can lead to a cash crunch.
A cash flow projection is a really simple way to ease this issue. Your accountant can set up a cash flow projection and let you know how much cash you will have on hand in the next 10-12 weeks. This information can help you understand the finances of your agency, as well as how a new hire or purchase will impact your cash flow.
For most creative agencies, the relative lack of capital expenses means that an agency can run without much debt. When debt is incurred, it can be a result of past mistakes or decisions.
Here’s a problem with business debt: every month you are taking money out of your business and there’s nothing you can do about it. This is money that could be going into new hires, agency growth, or profit for the agency owner. Moreover, it is not a tax deduction, and it costs more than face value because it is paid back in after-tax dollars.
Tips on Taking on Business Debt:
At times, taking on debt to fuel your agency’s growth may be a good choice. When taking on this type of debt, be sure to think through the implications and how this debt will affect future growth and financial planning.
Take your time when planning to get a business loan. The quicker you need the money, the more expensive it will be. Sources like Kabbage or PayPal Business will charge very high interest rates; surprisingly it might make more sense to put charges on a credit card. Local banks with a line of credit will require more time for an approval process, but you will likely get more favorable rates and a longer payback.
4. Uncontrolled Growth
A growing agency is an exciting place to be, but uncontrolled growth can affect the financial stability of a business. More signed contracts lead to more revenue, but it also leads to more expenses as you need to staff up to handle the projects. As you ramp up hiring to meet expected demand, you are paying for the expenses of today with tomorrow’s revenue. If those growth numbers drop by even a little bit, you can quickly find yourself in a cash flow crunch.
5. Lack of Profitability
If your agency is profitable month over month, and you are not pulling profits from the business, it is very rare that you will have cash flow issues. If this is not the case, it is because either the business is not profitable, or the business owner is pulling more money out of the business than they should.
Here are some tips for keeping your agency profitable:
- Make sure the business is profitable. What is the bottom-line number for the business this month? Are you sure it’s on an accrual basis and accurate? An agency owner should always know how much money the business made each month.
- Look at how much money is being pulled out of the business. There are different tax strategies for a business owner to take money out of the business, but this also plays into the agency’s cash flow. Make sure your tax strategies line up with your overall business strategies.
- Leave 50% of profit in the business. I recommend following a simple formula for taking profit out of the business:
(Profit for the month – debt payments) / 2 = Maximum amount the business owner should take from the business.
Why leave the other 50% profit in the business? First, you can use this money to pay taxes. Second, this money can be used as an emergency fund for the business. That way, a downturn in revenue won’t affect cash flow.
Plan Ahead and Avoid Cash Flow Issues
As a business owner, gaining clarity of your agency’s current and future financial status is crucial in making decisions. Armed with the right information and an agency accountant by your side, you can avoid cash flow issues and keep your creative agency on solid footing.