Agency owners with cash flow difficulties often think that taking out a loan will solve all their cash problems.
However, before taking out a loan the agency should look at why it really needs a loan and why the cash flow difficulty has risen in the first place.
There are three reasons that cash flow difficulties arise and why you might need funding of some description.
Lack of profitability
Agencies’ biggest costs are their people. If an agency’s team is fully occupied and the agency is charging the right price for the work done then there shouldn’t really be a need for external borrowing.
You can check whether your profitability is right by having a look at your margin and making sure that it’s in line with industry average.
If your margin is lower than industry average it means one of three things.
- If your team are really busy, yet you’re not making any profit, it means that you’re undercharging for your services, or
- Your projects are suffering from “scope creep”
- Finally, don’t trust the timesheet. Are your team has sat around, underutilized
Cash needed to fund working capital
Working capital is the time difference between when you have to pay out for a project, e.g., staff costs, freelancer costs, and when you receive the money for that project from your customer.
Agencies often measure this working capital requirement in terms of their aged receivables or debtor days.
By managing to reduce that working capital requirement, you could reduce or eliminate the need for a business loan.
You can reduce the working capital requirement by changing the terms of business with which you work with your customers. For example, most agencies will bill with a 30-day credit terms built in. Reduce that to 14, and you immediately half your working capital lead.
We’ve seen many agencies who just bill at the end of a project or leave the completion of the projects in the client’s hands. For example, they can’t billas they are waiting for content from a client.
Changing terms of business, so that you bill in so much upfront and so much at staged milestones throughout the project puts the power back in your hands.
An expansion loan
This is probably the only time where we couldn’t reduce the need for a loan.
It’s quite possible you’ll take on a great new client where you need to bring in new skills to the agency or the agency’s rapidly growing and you need to take on more cost before you can even think about billing a client.
In this case, taking out a short-term expansion loan might prove to be the right idea.
In summary, it’s all too easy to go to the bank or a nontraditional lender and seek to raise extra finance. However, before doing so, look internally at your business and see what’s caused the cash-flow problem in the first place.
If you are considering a loan and aren’t too sure if it’s the right thing to do, please give us a call