What’s the Right Amount if Cash On Hand?
Recently in the Grow Your Agency Slack, the following question was asked: “How much cash should an agency hold?”
This led to great conversation within the community, and while I provided an initial response, there’s a lot more that goes into answering this question.
Here’s what I originally shared:
But, it’s important to expand on that to answer the question fully.
The goal of having a cash reserve is to mute the impact of financial distress on your firm’s enterprise value (EV). Any excess cash should be reinvested or distributed to shareholders.
But that cash contributes to your firm’s value. So, won’t spending it in times of distress reduce the EV just the same?
NOPE!
Cash in a knowledge-based firm, like a digital agency, is there to protect intangible assets that have a significantly higher impact on EV than their cost. At the risk of sounding like some cliché, your greatest assets are your people.
Let’s review this with an example: If you have to cut back so far that you lose a senior member of your overhead, say someone on the revenue generation team (a senior salesperson or marketing director), the losses incurred from limited future growth far outweigh the cost of their salary. Therefore, it makes sense to hold and spend cash to retain them because it’s cheaper than the cost of lost growth and replacing them later. The same goes for core members of your production team.
So, how much cash should an agency hold?
The right amount of cash depends on three core variables:
- The possibility of financial distress occurring
- The potential impact of financial distress on your firm’s EV
- The owner’s personal risk appetite
The first one is the hardest to predict and thus the hardest to model. I wouldn’t waste much time building out anything fancy here. Keep informed of significant moves in your client’s industries, pay attention to macro shifts (inflation, war, etc.), and you’ll be able to trust your gut on this one.
The magnitude portion is easier to model. Take a few scenarios, play out what you’d do in each case, then run the numbers. What’s a 25% drop in sales for a month do? What about a 50% drop for three months? Understand what your core continuation team looks like and calculate the cost to run that team for the time it would take them to dig their way out. There’s a point where it makes more sense to close your shop than to push through. This exercise should give you a sense of where that point is for your agency.
Finally, understand how much risk you’re comfortable with. This should be extended to that core continuation team as well.
There isn’t a set answer that is the same for everyone, and as your business grows or changes, that number will change too. Running the exercises above will get you close to an estimate that works for your business.
This is why everyone says “3-6 months of OpEx.” It’s an easy out for a question whose answer can become complicated quickly. There’s also the question of what form that cash should take, aka “what’s the optimal capital structure?” In an inflation-heavy environment, a tilt toward debt may make more sense.
Data Point
Recent survey results, benchmark data, industry metrics, analysis, and new survey opportunities.
 |
We recently published our 2022 Digital Services Outlook Report in partnership with the Bureau of Digital. Some of the highlights from the report include:
- Digital shops grew 25% last year! Owners predicted a great 2021 and they delivered with exceptional revenue growth. The average shop served 41 clients and added 12 new clients last year.
- That revenue growth was profitable with the average shop delivering net margins of 17%. Longer client tenures correlated with higher profitability.
- Better pricing = better growth. Average hourly rates shifted up last year with 40% raising prices. Those that did raise their rates grew 20% faster than those that didn’t.
- The specialist/generalist split remained even at about 50/50. Interestingly, specialists only grew slightly faster than generalists but reported lower margins.
- Owners are expecting another great year in ’22 with outlooks coming in just as optimistic as last year. One potential headwind lies in a challenging labor market with most owners expecting difficulty here.
Copies of the report are available via their newsletter.
Our Top Posts from the First Quarter
The latest articles from our site about running a digital agency.
 | How to Calculate a Retainer FeeThe retainer fee price structure is frequently used. It is well understood in the world of digital agencies. If this is a route your organization is taking, you must know how to calculate a retainer fee correctly.
|
 | Financial Metrics for Marketing AgenciesMonitoring the right metrics can make growing a digital agency significantly easier. By regularly monitoring them, and asking the right questions, they can reveal where you should focus your team.
|
 | Setting an Hourly Rate for a Digital Marketing ConsultantIf you are running a digital marketing agency, no doubt your client list has grown, and their needs are expanding exponentially. With demand for digital marketing services at its highest point ever, now is the perfect time to strategically consider how much your services are worth.
|
