💯 💯 💯 "It actually makes the most sense to start visualizing the word profit as an accounting term, as opposed to actual money. In fact, your books, your financial records, they're actually going to recognize profit when an invoice is created and sent to your client, regardless of when the payment is received."
EP 21: How do profitable businesses run out of money? This is a concept that was foreign to me when I first started freelancing, but soon enough I discovered the value of understanding how a healthy cash flow acts as the lifeblood to a self-employed business. In this episode, we dive into what cash flow is, how it relates to profit, and how to identify the cash-flow killers that could leave your business vulnerable.
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Michael Der 0:02
You're listening to Artrepreneurs, a podcast that inspires photographers and visual artists to live their best creative lives. My name is Michael Der and I am a full time photographer with nearly 10 years of experience in the freelancing world. And I'm sitting down with an amazing community of visual artists to talk about process, business, and the lessons that have helped them grow. So let's get to it. Artrepreneurs starts right now.
Okay, what is up everybody? Welcome back to another episode of Artrepreneurs. I am so honored to have you tuning in and joining me on this journey. Today, we've got a good one, we're going to tackle how a profitable business can actually run out of cash. How is that even possible? And maybe more importantly, how do we prevent ourselves from becoming one of these statistics? No, I'll be honest, this concept absolutely baffled me too. When I first ran across this question years ago, my simple brain just couldn't understand it. But my experience as a self employed Freelancer has taught me firsthand how I can simultaneously gain profit. While also completely run out of money. What I experienced was not only bad management of my finances, and my clients, but really just a lack of understanding of a fundamental business concept, something we refer to as cash flow.
So cash flow is the measured amount of money flowing in and out of your business, typically measured by a set term, like a month or a quarter or a year, it is the balance of how much you earn, which is your income, and how much you spend what your expenses during that term.
So if your expenses outweigh your income, meaning that you're spending more than what you're making, you will have a negative cash flow during that time. If your income on the other hand outweighs your expenses, meaning you're making more than what you're spending, then you have a positive cash flow.
Now, for those of you who are a little familiar with business terms, you probably just heard me describe the exact concept of profit, which is revenue minus expenses, it sounds like the exact same thing. So how are they different? Well, for me to understand this concept, it actually makes the most sense to start visualizing the word profit as an accounting term, as opposed to actual money. In fact, your books, your financial records, they're actually going to recognize profit when an invoice is created and sent to your client, regardless of when the payment is received. So think of it as profit, but in theory. Just because you are profitable doesn't mean that you have an accurate reflection of the money that you currently have.
For an example, if a client commissioned you to do a shoot for $2,000 at net, 30, which means that they pay you within 30 days of the job, and it costs you $500 to produce it, maybe you hired an assistant, maybe you paid for parking, you got some food for the crew, whatever it may be, from a profit standpoint, you have technically profited 15 $100 at the time of invoice, right. $2,000 in sales, $500 in expenses, but because the terms are net 30, they decide that they're going to send the check out at around day 25. So even though your books might say that you're actually profitable 15 $100 this month, what do you really have to show no money has hit your bank account yet. So from a cash flow standpoint, you're down $500 for the month.
Let's look at another example. Let's say you run a contracting business in home renovation, this always makes it a little bit easier to visualize because the scope is so much bigger, and the consequences are very obvious. So let's say you get contracted to build a new kitchen for someone for $50,000. The profit margin is very good. How would you as the owner of the company afford to pay for materials and labor? If the client decides to pay you only on the day of completion? The answer is you couldn't because you don't have the actual cash at your disposal, you may be profitable, but you aren't cash sufficient. This is why this concept is so important to understand.
Now, understandably, freelance photographers typically don't have the same overhead costs as big contracting businesses. But the same principles do apply as they did to me. When I first started freelancing, things actually got off to a very quick start, I was traveling the country every week, which required a lot of upfront expenses for flights, hotels, rental cars, gas, food, all of that around 35 to 40 weeks out of the year. So that's all well and good when the payment comes in to reimburse you very quickly, which at that time was net 15. So every two weeks, I'd be getting paid for my expenses and my services. So that is an example of a moderately healthy cash flow. But it's only predicated on that consistent pay period. If the money stops coming in every two weeks, you can quickly run into trouble. So for all of you employees out there who get paid bi weekly, all you have to do is imagine what would happen if your employer stopped paying you. That's what happened to me. My client couldn't keep pace paying their photographers at a higher frequency rate than what their business was actually generating income. So they had to course correct and tell us the terms had to be changed to an unspecified time, instead of net 15 payment it became Net "don't call us we'll call you." So as I accepted their undisclosed terms, two weeks became a month, one month became too too much became three. Keep in mind, I'm still working for this client. I'm still traveling for them putting up a lot of money for Ubers flights, luggage, hotels, rental cars, you name it. We're talking maybe 2500 to $3,000 that I am fronting on my credit card each month without reimbursement. So this goes back to that concept that I
started the show with, you know, how can one achieve profit, but also run out of money at the same time. And this is how. Solely from an accounting standpoint, my business may have shown an actual $10,000 profit in that timeframe. But my bank account was saying negative 10,000. So that's a big distinction between profit and cash flow, and to boost my credit card interest at 25%, or whatever it was compounding daily, extrapolated over many months, ultimately meant that if I ever did receive the money that I was owed, the value of that money would be significantly less valuable because the amount of penalties and fees that I was incurring on my credit card payments would chip away at the earning power. So realistically speaking, the value of that income when I finally got the payment was worth maybe 60%, of what it was supposed to be initially.
So for me, there were three cash flow killers working their magic at the time of this crisis. The first one is the high production costs, which for me, are my travel expenses. The second one was the credit card interest that I incurred that resulted in me not being able to pay off those expenses in time. And then the third one, the last one is the delinquent payments themselves. This was a first class as whopping of a lesson on how negative cash flow can kill a business. Now, I am proud to say that my business did bounce back, but it took over three years of diligence and financial savvy to overcome the three months of bad luck and financial ignorance in the first place.
And so my PSA to all you freelancers out there is to be aware of this concept to look out for potential areas where your cash flow could be at risk, the reality is nothing suffocates a business quite like a lack of money. So I'm going to list five key areas to monitor that can help you going forward outside of just getting more clients.
Number one, look out for bad payment terms. Unfortunately, a lot of creative contractors they get paid well after a job is completed. And it sucks because you could never eat at a restaurant and then pay 30 days later, but you can hire a photographer and pay him or her 90 days later, I once took a job that paid nearly eight months after the shoot, which I'll never do again. Because my bills come in every month like clockwork, the payments that I received need to match pace with my bills. So if you can renegotiate for faster payment terms, like net 15, or even same day pay, I suggest doing it and if you can get your clients to agree to an upfront deposit. Even better deposits can be your best friend for anyone who has a lot of travel expenses like I do, as they will cover your costs for hotels, flights and rental cars.
Number two stay on top of outstanding invoices clients have been known to stretch the timeline a little bit on payments, so it's not uncommon to see your net 30 contract turned into a net 41. Very quickly, I tried to encourage my clients to pay on time in a few different ways. One, I set up direct deposit or credit card payments, those have been known to collect faster, too. I offer discounts for early payments, which actually create a win win scenario, one for my cash flow and then two for my clients bottom line. And lastly, I articulate that penalties apply for delinquent payments, something in the neighborhood of maybe five to 10% for anything delivered past the due date. Small incentives like this can really be effective in getting your payment faster.
Number three, note when your large one time expenses occur and then plan around them. So most of our normal expenses are very easy to budget around because they are consistent. You know what your mortgage is going to be? You know what your phone bill is, you know, your car insurance, your gym membership, etc. Those figures are very predictable because you see them in your bank statement every month. But what about the big purchases that you might forget about because they don't come up as frequently? Do you know the dates of your quarterly tax payments, if not write those dates down. So you know when the big withdrawal is coming out of your savings account. I have the distinguished honor to have my liability insurance premiums and my website hosting withdrawn once a year in the same month. So I make sure to note when that AutoPay occurs because that automatic $1,000 withdrawal is not a fun surprise. And what about all those subscription services that offer a discount when you pay once a year instead of each month? Do you have a timeframe on when you plan on upgrading your photography gear or your computer equipment if not set a date and a target month so you can plan accordingly. If you know what months your biggest expenses come each year, you can actually plan around it by spending less on the discretionary expenses like dining clothing entertainment and save them for the month where you have more cash flow coming in.
Number four, predict your lean months. You don't have to be a seasonal wedding photographer to know if you have slower months than usual one year freelancing and you'll have a gauge on the seasons that will likely peak and the seasons that will likely slow down. This should help you plan a cash reserve during your heavy months so you can keep the lights on during the lean months. Dry times are also a great opportunity to spend money on marketing and personal projects when the clients aren't coming in. So be sure to have enough saved up and don't spend everything you earn when things are going really well.
And then five, watch out for your slow bleeds. One of the best ways to manage negative cash flow is to simply be aware of where the holes are in your life raft. Are there any small monthly purchases that you make that you can do without now I don't want anyone to live their lives to defensively but in self employment and life in general. I do think living within your means is important. Secondly, assess your debt situation. Student loans are a slow bleed but credit cards and car loans are just killers. Not only are the interest rates astronomical but these are areas where compound interest will actually be working against you. Now admittedly killing off debt and living smaller won't increase your cash flow coming in. But it also won't be contributing to any negative cash flow going out, which is just as valuable and something you should see as a win.
And for those of you who are looking to scale with much higher monthly expenses like payroll, rental space and manufacturing costs, you'll definitely want to make sure your business has the likelihood of repeatable and consistent monthly revenue. So for those who are looking to open up their own studio, or hire other contractors or staff positions and produce product inventory, you should absolutely prioritize that business model that creates cash flow in your favor.
So to review folks, profit and cash flow are very close related, they both measure the balance of your income and your expenses. But profit acts more like an accounting concept than literal money in your hand. Cash Flow, on the other hand, is the actual amount of money flowing in and out of your bank account. So it's a far more realistic perspective of how much money you have and what you can and can't afford. So be sure to watch out for cash flow killers like late payment terms, outstanding invoices, large one time expenses, dry months and debt.
Now you may have noticed that I didn't mention anything about combating negative cash flow by picking up more jobs. And that's simply because it's maybe a little bit more obvious a solution and quite honestly a lazy answer. If you are in dire straits. Obviously, it might be wise to seek a second job or create another side hustle, your ability to bring in income is always going to be your most valuable asset as a professional. So I don't want to downplay that. But I also don't want you to lose sight of how important it is to not go broke.
Running your own business is very much a blend of offense and defense. You need to have an offensive mindset to seek out clients and generate revenue while at the same time you need to exhibit defensive skill sets to prevent financial loss and negative cash flow, most of which are actually in your control. The reality is for us self employed freelancers, we lacked the luxury of consistent, predictable cash flow like employees and staff created so we have to strategize differently, and more importantly, we actually have to act differently. And for those who are employees understand this concept now so that if you ever do start your own business and break off on your own one day, you will be mentally acute at eliminating unnecessary risk. All right, so that is going to wrap up today's episode folks. I appreciate you tuning in. I hope you learned something and I wish you the very best in your creative endeavors. We will be back next Friday morning with brand new content. My name is Michael Der and I am going to leave you with one last reminder as you head into your weekend. Profit is great but cashflow just might be king. This is Artrepreneurs season one peace out everybody and have a great week.
Transcribed by https://otter.ai