Picture yourself walking around NYC at night with noise-canceling headphones and your eyes fixed on your feet. Would you feel safe? Probably not.
Situational awareness is your friend: so you don’t get mugged, hit by a car, or find yourself nowhere near your destination.
It’s the same for a business. Good situational awareness can spare you a lot of trouble.
For an agency, the first three threat areas to watch are:
- Cash runway
- Client credit
- Client concentration
Cash runway
What if you had cash in the bank to cover 10 years of operating expenses? As long as you didn’t go on a spending spree, face embezzlement, or ruin your reputation, you’d be invincible.
Having plenty of cash runway gives you the breathing room to make the best decisions for your business.
- Turning away poor-fit prospects
- Firing bad clients
- Investing steadily in marketing & sales
- Standing firm on appropriate pricing
- Taking good care of your people
- Investing in your expertise and processes
A healthy cash runway gives you the confidence to take some risks, to try new things. It helps you maximize the value you create for your clients, your team, and yourself.
Here’s what you need to do:
- Set your cash runway target
- Compare your cash runway to your target every month
- If there’s a gap or negative trend, identify the cause, and fix it
If your agency is healthy (generating > 15% operating profit steadily, with a strong pipeline and no other notable risks), then 2 months of operating expenses may be safe. In general, aim for 3 months. And if you have any notable risks (an ugly pipeline, a client concentration issue, etc), aim for more.
(Note: These funds don’t need to sit in your business checking account; you want most of them earning good interest for you, but still liquid and accessible.)
If you’re already watching and improving your cash runway, give yourself a pat on the back! If you aren’t yet, take a few minutes to reflect: why aren’t you?
Client credit
Are you accidentally bankrolling your clients?
Since most clients pay their bills pretty well, we can be lulled into a false sense of security.
Stop and consider though: one larger client getting behind on payments could put you in a serious cash crunch – and could tank your profitability as well if they never pay.
I’ve seen this happen multiple times: a good client who has been a steady payer starts paying slower and then, in the end, never pays off their remaining balance.
The more frequent case is many clients each owing you a bit more than they should. Your bank balance could be higher – instead of theirs!
Build your credit management approach on these 3 practices:
1. Set a credit limit for each client:
- Make sure the caps are an amount that you’re OK losing entirely, worst case. I’d recommend a default limit that is less than 2 weeks of agency operating expenses per client.
- Require a rigorous process to increase a client’s cap (with a built-in expiration date, forcing a fresh review).
- Have a mandatory stop-work policy when a client’s cap is exceeded (no teeth = no use). And of course, give them a heads up in plenty of time.
- Tell clients about your policy and include it in your agreements.
- As you start, for anyone above their cap give them 30 days to get in good standing or agree on a payment plan with frequent installments to get below their credit limit within 90 days.
2. Have a credit check for all new clients:
- Talk to 3 credit references (e.g. their banker and 2 vendors).
- Pull a credit report on their business.
- If a potential client is a credit risk, simply require advance payment. This can be done with frequent payments via bank draft to limit their exposure too.
3. Institute a process to review the credit of all accounts monthly alongside a general review of accounts receivable.
- Have a standard set of communications ready (step by step) for any clients over or at risk of going over their credit limit to make this easy and efficient.
- Feel free to use good cop / bad cop by having your COO or CFO be the escalation point communicating with clients just before stopping work.
A few hours of effort could save you hundreds of thousands in unpaid receivables and a lot of sleep loss.
Client concentration
As agencies, we’re always looking for great new clients who want to do a lot of work with us. But what if a client does want to do a LOT of work with us?
This is often what can happen:
- We accept a gorilla client at reduced rates (“we’ll make it up in volume”)
- We hire to meet the gorilla client’s needs (“we need help”)
- We slow down marketing and sales (“we’re busy”)
In short, we create the potential for a lot of pain in the future.
Let’s look at how we can decrease the risks and increase the rewards of gorilla clients.
First, face your client concentration risks. Calculate the percentage of your revenue from each of your top 5 clients (looking back and ahead).
You have a notable threat if over 20% of your revenue comes from one client and another layer of risk if more than 40% of your revenue comes from your top 3 clients.
Next, assess your level of risk in a worst-case scenario. How would it affect your agency if your largest client left overnight? Decide what an acceptable level of client concentration is, just like with client credit limits.
Once you understand your risk, take appropriate action:
- Only accept gorilla clients with above-average margins.
- Maintain a longer cash runway, so you are still OK if a large client leaves.
- Invest a good share of the additional profit in building your sales pipeline. If you want to grow, focus on landing more clients like today’s gorillas until what was a gorilla becomes typical.
- If you aren’t prepared to grow, spread the work over more time, creating more security instead of less. Or partner with another agency (or freelancers) to complete the work together, retaining your share of the profits.
We’ve covered three of the most immediate threats to agencies:
- Insufficient cash runway
- Client credit issues
- Client concentration issues
A little effort now in each of these areas can spare you a great deal of stress and loss in the future.