How Much Cash Should Your Agency Keep on Hand?

Sei-Wook Kim (00:02.784) All right. On today's episode, we'll be talking about cash flow management and more specifically, how much cash do you leave in your agency business? What are things to consider and what factors determine how much cash the agency should keep on hand? Peter Kang (00:09.635) Yeah, so this is a topic that's near and dear to our hearts. With agencies, cash flow management is often a very stressful thing. Folks have to navigate sometimes clients paying too late, payroll coming due, other expenses. Maybe we could start with just an overview of our philosophy and approach to cash flow management in an agency — how we think about best practices and what we adhere to. Sei-Wook Kim (00:59.19) Yeah, definitely. To start, it might be helpful just to understand that when you look at your P&L statement, it's typically done on an accrual basis. Some companies do this differently on a cash basis, but we do our books on an accrual basis, which represents a picture of the business. So if done right, it represents the revenue that was recognized — technically, worked on — in that month, and all the expenses that tie to that revenue in that month. That should give you a clear picture of the true profitability of the business. What it doesn't show you is the relationship to cash, because it doesn't say whether those clients paid or not, whether you actually invoiced for that work, and the same thing for all the expenses that went out — did they really align with that period, that month or quarter or whatever you're looking at. So cash is a completely different picture that we've looked at in a variety of different ways. I feel like we've made every mistake in the book on this area over time. But cash is ultimately the lifeline of: can you run your business day to day? Do you have enough on hand to, number one, pay your team members, vendors, and expenses, and then continue to keep the lights on going forward. Peter Kang (02:30.126) Yeah. Just to be crystal clear on that — there are instances where, on paper, you might have had an amazing month or quarter on an accrual basis. You had really amazing revenues and you kept your costs low, so on the P&L it looks like you had some amazing paper profits. But what you're saying is it could be a totally different picture in the bank account. What are the reasons why that might not match up? Sei-Wook Kim (03:05.772) Yeah, so typically a lot of it comes down to invoicing frequency, both from a client standpoint and for all of your freelancers or variable expenses. Let's say you're a project-based business and you design your contracts to be 50% upfront, 50% at the end, and the difference between the start and the end could be six months. You'll have a long period of time where you're paying out your team members to do the work against that project, but you're not going to receive the money for the last 50% until much, much later. So you can easily see how it can be flipped — where on an accrual basis you might recognize it as 25% a month across the duration of the project, but from a cash standpoint you may not have that money in your bank, even though you have to pay your team on a more fixed, regular basis. Peter Kang (04:09.985) Yeah, and so in that situation with 50% due later, if the client is also late on paying it — let's say they're a month or two months late paying that last 50% — what could happen to the business? Sei-Wook Kim (04:23.946) Yeah, definitely. Aging accounts receivables all the way across the board could lead to the same thing where you just won't have cash in the business to meet your expenses. What is advisable here is having some kind of cash buffer in the business — some reserves, or access to a line of credit — to really support you in those lumpy months. And this is purely from a cash flow standpoint. It's not cash to pay for projects where you might have lost money. This is purely the timing of when you get money and when you have to pay out expenses. Peter Kang (05:12.246) Yeah. So going back to best practices — what are some ways to design how the agency gets paid for projects and how they handle expenses? What are ways to better manage cash? Sei-Wook Kim (05:29.995) We learned this lesson the hard way. We used to do a lot of what we just described — 50% upfront, 50% at the end for these longer projects. Over time we updated our contracts. Starting on the revenue end, we have a lot more frequent invoicing intervals, in some cases every two weeks even if it's a six-month project — really splitting up the revenues so that you're receiving money in the cadence that you're doing the work. In most cases you might even be invoicing ahead of the work, and there might be a 15 to 30 day payment term with your client, but generally speaking you're getting cash on a very regular basis. And then with your team members, salaried team members are paid consistently every two weeks typically. But if you have vendors or freelancers tied to a specific project, we've designed it so that we're never in the opposite position where we pay out someone before we receive the money from a client. We always try to be cash flow positive from that angle. If you continue to run your business that way, you actually don't need that much cash in the bank as an emergency reserve. Peter Kang (06:59.659) Right, that smooths out the cash flow. And it almost sounds like you're trying to mirror what's happening on the accrual side as much as possible, so that the cash flow follows the work as you get it. How about with our more retainer-based businesses, where there's a negative cash conversion cycle — where we're actually able to get paid upfront for the work before we pay out the expenses? Can you speak a little more to that dynamic? In these retainers, especially when we invoice at the top of the month — what happens then? Sei-Wook Kim (07:41.598) Yeah, for the retainers you're usually invoicing at the top of the month for the following month. In some cases clients pay by credit card or ACH immediately, so you get the cash immediately. But the team that works on it, you'll pay afterwards — in some cases net 30 beyond that. So you'll always have float in the bank for the work and the expenses that happen afterwards. That's the ideal scenario where you have more cash in the bank than what you need to pay out later. Peter Kang (08:18.101) Let's take another situation. You talked about 50/50 — there is a period where if you get paid half a million upfront on a big million-dollar project before you incur any cost, how should an agency think about the cash flow situation there? All of a sudden there's half a million sitting in the bank — should they use that to pay some other expenses, play with that money, invest it and try to make something off of it? What's our take on that? Sei-Wook Kim (08:56.903) Yeah, I remember this happened to us where a client wanted to prepay the next year's expenses in December of the prior year for their accounting or reporting purposes. So we were sitting on a year of revenue. If you just go through the typical calculation of distributing money at a certain time interval, you could easily distribute way too much versus what you need in the future. In situations like that, what we did was set aside reserves of that money in particular, because we knew we were going to have to incur expenses against that contract for the next 12 months. It's almost like a separate allocation or bank account in some instances where you hold that money and slowly distribute it back into the main operating account. Peter Kang (09:48.951) So it's almost like, don't raid the cookie jar — just take amounts as needed as we do the work. Okay. So we talked about some of these best practices: designing the scopes of work and the invoicing cadence to match the work we're doing, and matching the SOWs with the subcontractors to make sure they're getting paid to match the work. Let's say an agency is doing that well and starting to build up cash because they're doing work profitably. What is the right amount of cash a business should think about holding in their bank accounts? And how do we think about cash for reserve purposes versus other things like taxes? Maybe we can dive into those considerations. Sei-Wook Kim (10:50.49) Yeah, the answer varies based on the design of the business. If you are a very project-based business where the cash is very lumpy, you may need to keep a lot more cash in the business — call it three to six months of expenses in cash. But if you're a more retainer-based business where the cash comes in a very consistent cycle, it could be lower — call it one to three months of expenses in the business. There's a risk to keeping too much in the business: you may get too comfortable, and you may take on risks with projects, keep a team member that might not be performing, or really compress your margins because you have the feeling of having a lot of cash in the bank. What can end up happening is you start burning down your cash reserves and running a not-ideally-profitable business. I think there is a good exercise in distributing profits at a regular interval — whether that's partners putting it aside in a different bank account — and then deciding what to do with that money, whether it's reinvesting in the business intentionally or even going out and doing some M&A to acquire another business line. Peter Kang (12:27.121) Right. A good example to talk about — because I think this has happened to a lot of other agencies and we've been in this situation as well. You have a period where you build up a pretty significant cash reserve — beyond three months, maybe six months, sometimes even a year's worth of cash that can cover all the expenses. On paper, you might think, okay, we have a very strong balance sheet, we can weather storms. And in such a situation — I've heard this in conversation with other agency owners too — you're doing well, but then all of a sudden new business dries up, you have some client churn, and you have this sense of, hey, we have the cash, the business will pick up again, let's weather the storm. In those instances, typically the agency owner will draw on those cash reserves to make payroll, to keep the team together. We've done this, we've talked ourselves into: look, we're protecting jobs, we're keeping the team together because this is a good team, and we want to make sure that when the opportunities come back, we're ready to service them. Why is this, in the long run, not advisable? And what are the alternatives and how do we think about such situations now? Sei-Wook Kim (14:15.15) Yeah, ultimately it's the owner's decision on how they want to spend their money. And it's interesting — if you do have the buffer, you do have the luxury and the ability to say, I'm going to keep this team because I think this is a temporary dip, it'll come back, and we're going to need those team members in three or four months. If you can weather that storm and get through it, that's definitely a decision that could be made. If you didn't have that cash reserve, you'd be making very different decisions. And no one can predict the future, right? Is the dip going to be for one month? Is it going to be three, six months? At a certain point, the owner and the key stakeholders need to decide how long is enough to keep burning down on reserves. It's an emotional decision, not a clear one — knowing when you are burning down on your cash and running a not-profitable business. Peter Kang (15:32.167) Yeah. On one end of the spectrum, you go, hey, maybe we should be ruthless — the moment business signals a downturn, you make cuts right away, brace yourself, make proactive cuts, keep expenses low, and don't have to tap into any reserves. On the other end of the spectrum, it's protect jobs at all costs and use your own dollars to get through the tough period. Both have pros and cons. If you're way too ruthless, you can sacrifice really good talent that would've been handy in the long run. But at the same time, if you're too slow, if you don't confront the situation in a clear-eyed manner and make tough decisions, it can lead to a vicious cycle where you've gotten into the habit of drawing on reserves to get through tough periods. I think that impairs your ability to run a good business in the long run. So maybe there is a happy balance where you make decisions a bit more rationally — hey, I do need to preserve certain talent, but I also need to make some tough decisions. Sei-Wook Kim (17:00.399) Yeah, definitely. One thing that definitely helps in situations like that is having a clear view of your cash flow forecast. We've gone through a variety of different evolutions of this through the years. At one point in our initial business, Barrel, we had an almost full-year rolling forecast with more granularity on the three months forward — literally every invoice with when we thought it would come in, if it got delayed what our new projection was for when we'd receive that money, and every single line item of expenses leaving your bank account. That level of granularity is not needed now, but in certain situations where you're really tight on cash and your profitability is down, it is a good exercise to run through to see where your bank account will be in three months. A day-by-day picture is very helpful. We had, in some cases, a weekly or daily look at how the forecast was doing. When times are better and your finances more accurately reflect the accrual picture, it's not needed — but it's a good exercise to run through. Peter Kang (18:40.037) Yeah, I distinctly remember that period because we had moments where we had hundreds of days of runway and it felt great — our business is solid. And then we had single-digit days where we were like, holy cow, if some of these payments don't come through, we are really screwed, insolvency is right around the corner. The imagery that was always on my mind was the old-time cartoons where there's a circular saw cutting the wood and a cartoon character is tied to that piece of lumber getting closer and closer to that buzz saw — but then the lumber gets extended and you get a few more days. We were always like, let's just avoid that saw and prevent ourselves from getting cut. That was always the feeling we had in the back of our minds. Nowadays it's a lot saner, and maybe you could get into how, as we've expanded from managing cash flow for one agency to now thinking about it centrally across our Barrel Holdings agencies — multiple agencies, supported by a centralized finance operation where cash flow management is handled centrally — how do we think about that? What's changed from a single-agency model to a multi-agency model? Sei-Wook Kim (20:03.662) Yeah, a lot of the fundamentals are the same. How we design the contracts, how we pay team members — a lot of those practices we've shared with all the companies in the portfolio. We go through a quarterly cadence of distributing profits, both to the existing team and to the holding company. On a quarterly basis, we're also allocating funds for taxes to go to the holding company as well. A remaining amount we leave in the business to continue growing each business's cash reserves. Then at the holding company level, we take the money and go through the same exercise — we do have expenses at the holding company level, we'll set aside an amount for reserves that we then use for investment into either agencies or M&A, and go through that same cycle with distributions. The advantage is we have reserves at each company and reserves at the holding company level. So in a catastrophic situation where one of the businesses runs out of all their cash reserves, the holding company can backstop them if needed. Peter Kang (21:19.946) Right. Just on that point of catastrophic situations — we've obviously had our share of them — maybe speak to when and how they happen. And in those situations, beyond just what you have in the cash reserve, let's say the business has whatever the appropriate amount is — two, three, four months — what are some other protections or things an agency can have in place so that in some of these unexpected situations, the cash reserves plus whatever else can help get them through? Sei-Wook Kim (22:11.469) Yeah, from a day-to-day operations standpoint, that amount of cash should be plenty — let's say all of your clients don't pay. In a worst-case scenario, you'll still have enough cash to make it through two to three months. But there could be situations like legal matters where a client ends up suing you or an employee ends up suing you, and the amount at stake could go way beyond what you have in the bank. That's where insurance comes into play — having really good liability insurance policies. When you don't need them, they seem like just an expense on your P&L. But when you do need them, they can really save your business. A lawsuit that is millions of dollars could easily take not only your current cash position, but future cash potential, and really just take your business under. It's an important part of making sure you have insurance for the right areas and enough coverage based on the size of your projects and the size of your business. Peter Kang (23:31.138) Yeah, and on the financing side — lines of credit, credit cards — when is it appropriate to leverage those instruments versus the cash reserve? Sei-Wook Kim (23:47.618) The line of credit — number one, it's good to have. As soon as you have the credit history that allows you to open up a line of credit, you should do that and continue to revisit the amount as your business grows. That's really a tool for emergencies. In terms of order of operations, it's almost always use your cash first, because it will be a lot cheaper than using your line of credit. A line of credit is typically an interest rate north of 10%, potentially even higher, versus if your cash is sitting in a savings account at let's call it 5% — much cheaper to use your own cash for temporary dips like that. Peter Kang (24:39.329) Yeah, anything on the credit card side? Some can be used as a line of credit on their own. Sei-Wook Kim (24:45.697) Yeah, some credit card companies give you lines of credit as an option. Some have 0% interest for a number of days. In some cases, it is appropriate to use that — it could be the cheapest form of just delaying a credit card payment for 30 days because they're not going to charge you interest and it's a temporary dip. In general, I don't love the practice of delaying things like that, but it could be cheaper than using your own cash for sure. Peter Kang (25:18.644) Yeah, it's not too different from personal finances where you don't want to carry a lot of credit card debt, and if you can pay with your own cash you do — but then there are some things you do want to finance over a longer period of time if you can. Sei-Wook Kim (25:36.064) Yeah, definitely. Peter Kang (25:37.439) Okay, great. As we kind of wrap up this episode, going back to that question — how much cash should an agency hold in their business? What's your final recommendation here? Sei-Wook Kim (26:05.537) I hate to say it depends, but — low end, one month; high end, probably six months of cash in your business. And if it goes beyond six months, it's only because you have some really big contracts that you're getting prepaid for and need to keep the cash on hand. Peter Kang (26:29.857) Yeah, and one last point we should make: a lot of times the cash in your reserves are amounts that you've paid taxes on for the most part — basically profits that you've decided to keep in the business. Beyond the cash reserves in your business, there is also cash that, as the owner, you can write back into the business. Maybe as a parting thought, you can reflect on that. Sei-Wook Kim (27:04.574) Yeah, you mentioned a good point. These are post-tax amounts. Every business does this slightly differently, but your cash reserves aren't the amounts you're saving for taxes — that's completely separate, expected to go out as a liability to the government. These are profits you're setting aside for reserves. Beyond that, the owner takes distributions, and if you do want to make investments into different areas, the owners could write checks into the business and be deliberate about measuring the return on those investments. In some ways, we feel like it's cleaner if you want to invest in, say, creating a software product within your agency or acquiring another business, to cleanly separate that out — almost like, don't muddy the cash reserves by spending that money for those purposes. Peter Kang (27:58.593) Yeah. Or in the situation we talked about — if I want to save jobs, if I want to help my agency survive — that's also a situation where the owner can write a check back into the business and treat it as a loan, treat it as an investment, whatever it might be. Those are valid reasons to think about cash reserves. Okay, well, thanks for tuning in. We'll see you all next time.