Wednesday, April 26, 2017

Going Pro: Working Capital-- How Much?

Jorg Gray Luxury Watch

When you’re thinking about starting a production company, odds, are your most pressing question is “how much working capital do I need to start my company?”  The obvious answer is that there is no magic number.  But there is a framework for thinking about working capital that can help you find the right number for you

Let me define my terms: “working capital” is my total monthly expenditures—both in life and for the company.  This includes the life bits like rent, food, internet, and gas; and the business bits like insurance, advertising, and depreciation.  I don’t include equipment costs in this figure, or set-up costs for company (things like website design, etc.).  I started with my kit pretty much intact, and I wasn't planning on buying anything in the near future.  If this was a watch shop, I had all of my necessary inventory, right down to the “Open” sign on the front door.

But video production isn’t like selling watches.  You need to factor in the turn-around time, from contract signing to final product.  If you shoot weddings, you may sign the contract a year in advance of the big day.  You need to make sure you’re in still in business when the wedding cake is cut.  (A more technical term for turn-around is cash flow.)  Turn-around time is project variable—some of my video projects wrap in under a month, others can go six before the final payment is made.  Personally, I decided my average turn-around time was 3 months. This means I need to have at least 3 months of working capital above my safety level.  Or panic point.

Media production also differs from a sporting goods store because the cost a wrist band is fixed; if you paid a fifty dollars for it, you can’t sell it for $49.99.  In media production you can (and probably should) charge less than a living wage on your first projects in order to build your resume and make connections.  A good rule of thumb to remember is that there are no "1-time discounts."  If you charge a client $500 for a video, that client will always expect his videos to cost $500.  You can charge the next client a thousand, but this one is pretty much set.  And that’s the path I took: my fee was above my physical costs for a project but below a living wage. Then I over-delivered on each product, and increased my rate for the next client.  I made exceptions to the “charge more” rule when the project was something I really wanted because of what it would do for my resume.

There's no such thing as a one-time discount

Since I began my production company as a part-time endeavor, I had the advantage of not starting at “day one” in terms of getting the word out and making connections.  I still had plenty to do, though, so I considered myself to be one month old as a company. Starting part-time, also gave me a better sense of my turn-around time, and how much I might immediately charge/earn for projects.  I could predict how much my monthly income would be in the beginning, how long it would take to finish a project (and thus charge more for the next one), and better predict how quickly my income my increase.  Remember, if your turn-around time is three months, your first month of income arrives in the fourth month of your company.

Find Your Panic Point

Which brings me back to my panic point.  If it takes three months to successfully make your first dollar, then it takes about three months before you know you’re not going to make that dollar.  If you have three months of working capital and the first project pays out in three months and one week, your business failed before it got started.  If, say, you have six months of working capital in the bank, then you'll have three months left when the first project pays out.  That three month mark I call the panic point.  But only having three months would mean I would always be living at my panic point.  That might be technically possible to maintain, but it really sucks to be on the edge of the abyss all the time.  And there's no wiggle room in case of emergency.  What you need is extra working capital to take the pressure off and allow for some degree of “failure.”  I set my goal at nine months of working capital in the bank.  I successfully overshot my mark: I opened shop with eleven months.

Let’s compare these estimates with national statistics:  Half of new businesses close in the first 2 years; 90% close within ten.  Those frightening figures are somewhat leavened by the fact that not all businesses close due to failure. Some are bought out; others just move on or retire. Six months of working capital is the most common recommendation for new businesses, and 12 months tends to be the longer, or outside recommendations.  Most businesses start with 3-6 months of working capital… and of course the majority of these are likely to be  the ones that close within 2 years.  “Service” types of companies, those that work from home, and those without employees tend to have less working capital to start, but don’t have a better survival rates.  70% of businesses start with less than $25,000 in working capital. Try to be in the 30% that has more. After researching the statistics, I decided I would have at least 9 months of working capital (which for me was more than $25K).

Save don't borrow

Best practices for starting a new company:
1.       Create working capital through saving not borrowing
2.       Start small and build up
3.    If the work you do in your studio can't pay for at least the studio, work from home.
3.       Track your finances studiously
4.       Establish yourself as an LLC or corporation to protect your personal finances
5.       Be a woman. Seriously, studies show women spend less on their businesses and are more likely to succeed in turning a small biz into a larger one

Strange tidbit of the day:  having too much working capital is also listing as a contributor to business failure.

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