The Best Way to Avoid Cash Flow Problems
Originally, I wanted to title this article “Ten Cash Flow Commandments” to pay homage to my favorite MC: Biggie Smalls. His song “Ten Crack Commandments” breaks down what a drug dealer must do to stay successful and keep making money. Fun fact: Lin-Manuel Miranda actually did a remix of this song to create “Ten Duel Commandments” for his smash hit musical, Hamilton. Like Miranda, I'm going to take some creative license using Biggie's song for inspiration to discuss effective cash management strategies for your agency business. I went with this title, "Cash Flow Problems & How to Avoid Them," in hopes that you wouldn't dismiss it as clickbait. Also, I only had five cash flow commandments—and that’s not a good title.
Rule Nombre Uno. Control your expenses.
Here's my rule of thumb: if you have three months of cash sitting in savings, then review your expenses monthly. Less than three months, and you should review expenses on a weekly basis with the goal of identifying areas to reduce costs.
Here are a few ideas to help you control expenses in your agency business:
Negotiate pricing with vendors to benefit from frequent purchases or increased buying volume.
Negotiate favorable payment terms with vendors.
Remind staff to ask for discounts. In the feverish race to get work done, your team can sometimes forget that there is an opportunity to ask vendors for discounts. A good time to do this is two to three months before a contract is to be renewed. This is not a ploy to cheat someone out of their worth. Instead, it’s a chance to partner with your vendors to ensure you provide a valuable service offering (in both the short and long term).
Consolidate purchases with one vendor to receive bulk discounts. Many firms join an agency network to unlock this benefit, allowing them to offer better pricing for media purchases to their clients.
Rule #2. Maintain timely and accurate financials.
This will give you a clear picture of your financial situation and help you identify potential cash flow issues before they occur. You should work on creating a “cash flow forecast” that outlines expected inflows and outflows, thus granting you valuable insight.
Here are a few ideas to help you maintain timely and accurate financials:
Use accounting software. Spreadsheets simply won't cut it when managing the complexities of a growing business.
Schedule regular bookkeeping. Set a specific time each week to update your financial records.
Hire a professional. Consider hiring a bookkeeper or accountant to help you maintain your financial statements. This individual should be able to provide you with reconciled financial statements by the 10th of the month. In other words, statements for the month of March should be on your desk by April 10th.
Rule #3. Improve your collection process.
The faster you collect from clients, the easier it will be to manage your cash flow. Many agency businesses have established a negative cash flow cycle. In this situation, you do the work and then invoice the client for payment. You’re forced to wait 30-60 days (often longer) to receive payment after the work has been completed. This means that you've gone through a few payroll cycles, you’ve paid invoices for any independent contractors, and also paid any out-of-pocket costs to execute work for your client. You have essentially floated money for your clients for the past two or three months. Your business can operate like this if you have enough operating capital (cash in the bank); but ultimately, it is wiser to try to shorten your payment cycle.
Here are a few ideas to help you improve your collection process:
Consider offering incentives for early payment. You should only do this with clients who typically don't pay on time.
Get paid in advance. Negotiate with clients so you can collect some type of deposit upfront.
Invoice earlier. Don't wait to complete the work until you invoice. Instead, invoice at the beginning of the work so your payment date better matches up with your completion date.
Make it easy for clients to pay you. Set clients up on auto-pay so you can directly bill their credit card. Provide numerous payment options (PayPal, Venmo, Cash App, etc.) to make it easier and more convenient for clients to pay you.
Rule #4. Match expenses with income.
The better you become at matching your income with expenses, the easier it becomes to manage your cash flow. As you onboard new clients, your project financials will dictate how to manage talent expenses. The projects margins will indicate whether you need to add headcount, or simply bring on freelance talent (due to the short nature of the project).
Here are a few ideas to improve your ability to match expenses with income:
Secure longer-term contracts. By creating longer-term contracts, you can better manage projects with your in-house talent. If your talent doesn't have all the requisite skills, then you can still work with freelancers to secure fixed-priced contracts.
Milestone payments. Match due dates on invoices with the work’s expected completion date.
Rule #5. Improve gross profit.
Your gross profit (also known as your “agency gross income”) specifically measures the cash you make from each client engagement.
Compared to revenue, gross income gives you a more realistic picture of your business’s performance. Bringing in $100,000 in a month might sound impressive (vanity metric); but if your Cost of Goods Sold eats up $80,000, then suddenly, the picture isn’t looking quite so rosy. To make sense of whether gross income is good or bad, you want to monitor it on a quarterly or annual basis to determine whether it’s trending up or down.
Here are some tips to improve gross profit over the long term:
Encourage clients to upgrade to higher-margin services. Explore opportunities to see whether your client will benefit more from offerings that provide you with higher overall margins.
Increase client retention. Marketing costs are an intrinsic part of doing business; but those costs are lower when you are able to up-sell current clients.
Cut low-margin services. Unless your low-margin services are feeder programs for high-margin services, it’s smarter to cut them entirely. If your systems are refined enough to show profit margins by service and/or client, then you can see which work is the most profitable. At this point, you can make a decision on where to invest your time in the future.
KEY TAKEAWAY
There are five essential cash flow management strategies for your agency business.
Control expenses, which involves negotiating favorable payment terms and discounts with vendors, consolidating purchases, and reviewing expenses periodically.
Maintain timely and accurate financials, including a cash flow forecast to identify potential cash flow issues before they occur.
Improve the collection process by offering incentives for early payment, creating earlier invoices, and making it easy for clients to pay.
Match expenses with income by securing longer-term contracts and using milestone payments.
Improve gross profit by encouraging clients to upgrade to higher-margin services and reducing the cost of goods sold.
By following these five cash flow commandments, your agency business can effectively manage its finances and avoid those critical cash flow problems.