One of the biggest challenges for creative businesses, especially fast-growing enterprises, is the management of cash flow.
When businesses fail, it’s frequently because of a cash flow crisis rather than lack of profitability. The gap between cash outflows and cash inflows becomes too big and they run out of cash. An unprofitable business will inevitably run short of cash but even profitable businesses can face a cash crisis if cashflow isn’t managed carefully.
As a business grows and its turnover increases, there is always a temptation to increase fixed costs. Then these higher fixed costs commit the business to regular cash outflows, even though the cash inflow may be more erratic, due to fluctuations in trade and delayed payments from clients.
I have seen businesses increase their fixed costs to such an extent that they are risking serious cashflow problems. In one company, a chief executive hired temporary staff to deliver short-term projects but then engaged them full time as employees, which meant that the company’s expenditure was no longer flexible, even though an endless supply of short-term projects was far from guaranteed. To feed the company’s new dependency on more and more cash, he then had to keep finding more and more projects, because they were no longer able to reduce their costs in lean times and ‘ride the waves’ of the ups and downs of business as they used to do. To avoid a cashflow crisis the company accepted unprofitable projects, to get a quick cash fix, even though it was digging itself into deeper trouble in the long term.
Unless future cash inflows are guaranteed to be steady, beware increasing fixed costs if you want to avoid cash flow problems.
Credit control is another major issue in managing cash flow effectively. Slow paying customers and bad debts can put a creative enterprise out of business, especially in the first few years when it is more vulnerable financially and less able to negotiate favourable trade terms with clients. Choose your customers carefully and agree a payment schedule through the project, ideally with a percentage paid up-front, rather agreeing to be paid only on completion of the job. Delays happen (often the fault of the client) which in turn delays payment and in the mean time cash is flowing out every week and month that goes by.
A cash flow projection spreadsheet is an essential tool for effective financial management of any creative business, so that potential problems can be foreseen – and then avoided.
Smart creative entrepreneurs keep a close eye on cashflow as well as turnover and profitability.