Have you ever worked harder than ever, and yet your finances don’t seem to reflect your exhaustion level? Have you ever had plenty of assignments to keep you busy, but still be financially underwater? Have you ever been desperate to collect on yesterday’s invoices in order to pay today’s bills? I think we’ve all been there at one time or another. It’s not for nothing that banks and creditors offer quick payment services (for 2-3% of your hard earned cash).
But here’s the thing. This situation is almost never what we think it is. We think it’s just a matter of cash flow. But really it’s a profitability problem exacerbated by a revenue recognition problem. A truly profitable practice consistently has revenue left over after covering expenses and providing basic compensation. And those reserves enable you to let payments come in on normal accounts payable schedules, with little stress. If you never feel cash flow pressure like this, then it’s probably because your operating profitably. Congratulations, good job!
But if not, then “cash flow pressure” is probably a common stressor. And the reason you aren’t seeing it as the profitability problem that it is may be due to what accountants call a “revenue recognition problem.” If you typically bill half up front and half upon completion, or perhaps in thirds, then you are definitely vulnerable to this distortion. A revenue recognition problem is what happens when you don’t distinguish effectively between your earned versus unearned revenue.
Here’s what’s really happening. You start a new project and you get half of your fee up front. You deposit it in the bank and use it to pay bills, or pay yourself, or what have you. The problem is, that money has not yet been earned. You will be working for the next few days or weeks to earn that revenue. Over that period of time you’ll incur more expenses, including your own compensation for all the time your spending on the project. It is possible that by the time you’ve been fully paid, that you will have incurred more expenses than the payments will cover. You’ll still be under water.
Of course a creative practice typically has more than one project going on at a time. And so your receivables forecast is going to always be a jumble of earned and unearned invoices. When you’re juggling multiple projects it can be extremely difficult to keep track of which payments have been earned, and those that have not. Thus revenue recognition problems are hard to detect. But if consistent cash flow pressure is a part of your experience, you’re going to need to straighten this out.
How can you solve this problem? The most important answer is to fix the underlying profitability problem, but the complex and multi-faceted issues there are beyond the scope of this article.
What you can do right away though, is to better insight into how revenue recognition is affecting your cash flow. This can be done by properly forecasting your receivables in a way that lines up payments with expenses that you will incur throughout the corresponding project’s schedule.
While getting your information straight won’t change the fundamental profitability problem, seeing exactly where you stand, and where you’re likely to encounter cash flow crunches, will help you prepare, adjust, and consider how this problem can be fixed.
It will also help you avoid the deadly tendency to make business expense decisions at times when your cash on hand happens to be high. We fool ourselves into thinking that we’re now finally able to spend some money, or take a little extra out of the business. But if that peak in your cash flow is not a signal of profitability, but just the influx of unearned revenue, then that peak will inevitably be followed by a valley. And if you’ve spent the unearned money, you will have to chase after new payments to meet expenses, which may likewise be unearned, creating a cyclical and downward spiral.
The best tool for keeping track of cash flow is a simple spreadsheet where you forecast the invoices that are paid, owed, or projected to be received, based on project milestone schedules. Layering that information alongside a separate tab that tracks your expenses over that same time period will provide a more accurate cash flow forecast. You’ll be able to see ahead of time the upcoming peaks and valleys.
I have a free sample cash flow template, in the resources section, that you can use if you’d like a head start. And my video library has a couple videos on exactly how to maintain this document. Of all the financial reports that any business ought to be using regularly, a cash flow forecast is by far the most helpful and illuminating.
Don’t keep drowning under waves of negative cash flow. Get a handle on this critical financial benchmark, and start to take control of the business side to your creative practice!