How Much Capital Does Your Agency Need?
Running a digital marketing agency requires you to have money on hand to make more of it. While bringing in new and retaining old clients sounds like the best fix, it takes a little more managerial flex than that.
Remember, cash is king. You need it to operate and grow your agency now and in the future. Let’s start by examining the root of capital needs: working cash flow.
It’s All About Positive Cash Flow
Your agency’s statement of cash flows is a telling document. It offers you a bird’s-eye view of your company’s performance in areas investing, debt, and administration. Not all agencies experience positive cash flow consistently, which makes it an important issue to address.
When your margins and costs start affecting the working capital you need, it’s time to make difficult decisions. How do you plan to get ‘back into the black?’
This situation is known as negative cash flow. In short, your agency is spending more than it’s bringing in. It’s the exact opposite of what any business owner wants since negative cash flow is symptomatic of:
- Not bringing in or retaining clients
- Passive or ineffective credit management
- Not actively managing accounts receivable
When you experience positive cash flow, your company has plenty of room for managing the business over the long-run horizon. You have the working capital needed to launch campaigns, pay employees a fair wage, and purchase the supplies you need to run daily.
If you’re starting up an agency or regularly are looking at your cash flow, you need to know what your working capital requirement should be. Here’s how to figure it out and get to it.
First Things First: Make Sure You’re Profitable
It’s a commonly held belief by marketing agency owners that profitably equates to an absence of cash flow problems. Unfortunately, like anything in life, it’s not as simple as being profitable. A profitable business is one that generates enough revenue to pay for overhead and grow the agency.
Running Your Marketing Agency Profitably
Measuring profitability comes down to a simple equation:
Sales – Expenses = Adjusted Gross Income (AGI)
Pretty simple, right? Absolutely. The only problem with this equation is that it’s a number created for accountants, no managers. So, it doesn’t necessarily tell you how profitable you are since there are other sources of revenue aside from sales and doesn’t actually tell you what your net gross income is.
Ensuring profitability starts with knowing your numbers inside and out. But you also need to know how to get there with that information. The first step toward profitability is forecasting your sales for the week, month, and year.
Take your company’s pulse when it comes to current performance. Set goals and work from there. Knowing what it takes to be profitable means you can actually get there.
What Is Your Breakeven Point?
Determining your agency’s breakeven point is a significant number. It tells you the exact amount of sales you need to equal your expenses. In short, it’s a number that tells you what you need to do to, well, break even.
Calculating your breakeven point is simple. All you need to know is the value of three financial variables:
- price of services
- fixed costs (FC)
- variable costs (VC)
That’s it. The formula for computing your agency’s breakeven point is shown below:
[FC ÷ (Price – VC)] / Price = Breakeven Point (in Units)
So, to find your agency’s breakeven point, start with writing down the fixed costs for the month. From that number, subtract the figure you come up with when you subtract your variables costs from the price. Take this number and divide it by your price. The final number you arrive at is your breakeven points in units.
Calculating Your Working Capital Needs
Knowing your expenses is a central theme of this article. After all, it’s the number that tells what your company pays for operating expenses such as payroll, rent, and supplies. It’s also a number that is easy to miscalculate.
When calculating your costs, it’s essential you omit any pass-through costs, such as your client’s media spend. Take the total number of your total monthly expenses and multiply by three. This number is your agency’s working capital requirement.
Here’s the equation to calculate this number:
Total Monthly Expenses x 3 = Working Capital Requirement
Now, calculating your total capital requirement by using this equation:
(Working Capital – Current Assets) + Current Liabilities = Total Capital Requirements
To run your agency smoothly, you need to meet your total capital requirements.
How to Meet Your Capital Needs
Always measure for future profitability before taking on a loan or drawing on your line of credit. Without doing so, you’re most likely just kicking the can down the road. Make sure you are also complying with the following:
- Pad your savings account with plenty of cash. Don’t take that company bonus!
- Raise additional capital by bringing in an investor
- Take on other debt to finance capital needs.
You may be close to having enough working capital or you may not. Either way, you need to be measuring it. If you drop below your working capital requirement, it may be a future indicator of cashflow problems to come.