Cash flow and profitability

Is cash flow the real problem? Or is it profitability?

When we’re checking in with our creative agency clients there’s a response that comes up time and time again: “Business is great but we’re having some cash flow problems…”

Without trying to teach these business owners what they already know (we’ve never really known why grandmothers would be sucking eggs anyway), we’ll ask them to check whether it’s really a cash flow problem they face or whether it’s one of profitability.

And it’s incredibly important to understand the distinction between those two issues.

So, buckle up and get ready for our quick guide to the difference between a cash flow problem and a profitability issue…

What’s the difference?

Cash flow and profitability are both about lovely wonga coming into your agency. But they are not the same thing.

• Profitability is having enough sales to cover ALL costs – the overheads of the business, tax and the owners’ drawings.
• Cash flow is about knowing WHEN you’ll get paid – and having enough cash in the business, at the right time, to pay those overheads.

As a minimum, you should be aiming to cover all those costs – that guarantees your short-term survival, at the very least. But building a creative business isn’t just about survival (and we’re sure you have bigger aspirations than just ‘getting by’). So you’ll want to have a bit of extra cash kept in the kitty – known as retained earnings – to build the reserves of the business.

Building these reserves has several benefits

Retained earnings give you something to show for all your hard graft and the hours sat looking bleary eyed at a Mac screen at midnight (we’ve been there, believe us!). They’re your prize and a neat scorecard of how the agency’s doing in real terms.

But they also have some very practical benefits:

• You have a nest egg to call on when needed – If you have a lean spell (and most businesses do, especially over the coming Christmas period) it’s likely that the business won’t cover it’s cost base for a short period. With retained earnings, you can call on these built-up reserves to plug the cash gap and tide you over until you’re back on track.
• Your business is worth more – The starting point for any business valuation is the reserves (also known as the net book value, accountancy fact fans!). So the bigger your reserves the more your agency’s worth, which may be helpful when looking for additional funding or investment in the future (not to mention getting a loan for that little holiday home you’ve had your eye on…)
• You feel like you’re working for something more than just a monthly wage – The great thing about building a business is that your earnings are unlimited. You draw out enough to live the lifestyle you want (try to reign in the spending on sports cars, if possible). But you can also earn more on top of this ‘monthly wage’ and leave it in the business for the future. So you’re not just making profit, you’re building security into the fabric of the agency and your own personal wealth.

So, when does cash flow become an issue?

If you’re not making enough sales to cover ALL the costs of running the business, you WILL experience cash flow issues. But the route of the problem here is profitability and you’ve got to find a way of increasing revenue or reducing costs (find out the secrets of profitability in our free eBook).

When you’re profitable but still struggling to find cash quickly enough, that’s a genuine cash flow issue. And it happens for 2 reasons:

1. Your agency clients aren’t paying you quickly enough.
2. Your suppliers’ payment terms demand that you pay their invoices upfront or very quickly

The good news is that there are lots of ways to improve both of these issues.

Getting paid quicker

How do you get clients to pay you more quickly?

There are a few areas of the agency you can rework to make that cash flow situation look a bit perkier.

• What billing process is in place? Could your processes and terms be improved to bill sooner?
• How do you collect payment? Could you use GoCardless for direct debit payments and/or payment services for fast card payments?
• How do you chase? Could you install automated email reminders to chase your customers for overdue invoices?

Getting extra time to pay your suppliers

How do you get a bit of extra time before having to pay those supplier bills?

Again, there are some simple solutions you can push for.

• Ask for better credit terms – talk to your suppliers and work that relationship to negotiate longer payment terms (beer may help!)
• Use free credit – interest free credit periods on credit card are a simple way to ease yourself through a tough patch, for example.

Getting extra funding into the business

If ‘money’s still too tight to mention’ (to paraphrase Manchester’s most infamous redhead) then you’ll need to look at funding. Any kind of loan will help you climb out of your temporary cash hole, but be aware that they’ll cost more in interest and fees of course – so explore the free options first, where you can!

If funding’s what you need, there are a few options:

• Overdraft – a bank overdraft gives the greatest flexibility (you can dip in and out, which means you don’t pay when you’re not using it and there are no repayment timing commitments).
• Invoice finance – this lets you get instant payment of your sales invoices (which is useful if you’ve got long payment terms enforced by clients).
• Loans – a loan is helpful for short-term cash flow issues that you expect to go away quickly. But always make sure you can repay those payments or you’ll end up in an even deeper cash hole!

Focus on the real issue

There are lots of ways to dig yourself out of a cash hole (My Accountancy Place rope ladders are on order as we speak). But the first thing to understand is whether it’s profitability or cash flow that’s your real issue.

• If profitability’s the problem, focus on making more profit and that gets to the route of the cash flow issue.

• If cash flow’s the issue, look at the free/low-cost ways to generate cash more quickly and hold onto it for longer.

• If there’s still a problem keeping in the black, look at funding (but this comes at a cost).

And if you’re struggling with any of these, you know who to call (not Ghostbusters, no). We’d love to sit down and talk through your profitability and cash flow conundrums. So give us a tinkle and arrange a catch-up.