The Virtual CPA Success Show for Creative Agencies: Episode 15
We are recording this in the midst of the COVID-19 crisis, but the discussion we have today will help your business whether you are struggling from the COVID-19 crisis or just going through a difficult time in general.
In this episode, we are joined by Jody Grunden to talk about using a forecast to get your business through a rough patch. Listen to learn about the main areas to focus on in a forecast, and how to get to the 15% net income model.
Jamie Nau: Hello everybody, and welcome to today's podcast. Today, we're going to dig a little bit deeper on a podcast that we just released. So our last podcast was on forecasting for revenue growth. So it just shows you how quickly times can change because obviously since we recorded that podcast, we're living in a completely different world with the coronavirus out there. So we're going to kind of take that to the another extent: how would you do a forecast if you have an emergency, or if the economy is looking low, or if you just have a problem with sales. So this is kind of the opposite end of the spectrum, forecasting for the opposite of growth, forecasting for downtime. So Jody, let's just start throw it over to you right away. So if I'm a digital agency and I know time's looking slow, what should I do and how should that affect my forecast?
Jody Grunden: Yeah, it's kind of funny, not funny, but it is ironic that we were just talking about the opposite of this just a few weeks ago, and times have changed dramatically since then. The unique thing is I've gone through, you know, I don't typically have a client base myself, but I've sat in and helped out with many CFO calls, and we've done just exactly this modeling that we're talking about today. We've done it several times with the same clients to get them where they're happy and satisfied, and give that comfort feeling, because what it comes down is that comfort feeling. You've got to be able to know, hey, where am I going as a leader? What's my company looking like? What are the different scenarios out there that can really make a company, spin on its end, that type of thing. So this is a huge, huge part of what you as a leader need to make sure that you do is just hop in and start scenario planning. And to break it down, it's very simple, you know, simple in a way that if you have the modeling already put together, this first thing you look at is your revenue, then your forecasting side, and then you look at your expenses and then you're going to break out, and kind of make sure they are in the right mold. So starting with the revenue side, you know that what you're looking at here is delays in projects, you know, delays, clients maybe pausing things for a little bit, maybe clients are not paying on time. All those different scenarios that may happen, you need to walk through them right now and kind of plan that out. So what we've done is we've asked clients to list out the clients that are in really bad shape, thinking that hey, maybe these clients might go away. Clients that are solid, no issues at all, they are humming along, and even clients who have clients that may be impacted in some way. So kind of just kind of looking at the crystal ball a little bit and saying, hey, which clients do we think may fade away? We've done the same thing with our base. Which clients are the most impacted? Well the clients they can't do business like the restaurants, you know, the barber shops, the salons, all those different clients really can't do anything. The opposite would be the clients that are maybe working for the food industry, grocery store industry, maybe doing web design, those are safer clients. So we've done the exact same thing. So the first thing is identifying what you think's going to happen over these next two, to three months, because that's really what we're looking at right away. The two to three months’ time frame, because really any further that's just pretty much guessing at that point.
Jamie Nau: Yeah the important thing here too is just to slow down a bit on the revenue side. What I've been doing is, a lot of times when I'm doing revenue forecasting, I do it at a pretty high level. I build the pipeline, I show what the revenue looks like the next three months and say okay, it looks good, we're in good, good shape, we don’t need to look at this forecast again in this detail for another month. But what I've been doing with my clients, and I've seen other people do it with their clients as well, is to break down that revenue by customer and go detail by detail, line by line and say okay, let's build a best case scenario. Let's build a best case scenario of what revenue could be if no one leaves, and go through our pipeline and figure out which ones are going to side with us. Then from there, you kind of build the other scenarios. I think the biggest thing, and you can go into that detail a little bit more, Jody, but I think the other thing here to remember is when times are tough, I'm looking at my pipeline and I’m looking at my forecasts every single week with my clients. It’s usually a monthly thing. But when times are rough, it's every week to see what how things have changed. So, again, that's the one thing I wanted to throw out there, during these tough times you want to make sure you're looking at those more frequently than normal because things do change that quickly, as we've all seen.
Jody Grunden: Oh, for sure. So what’s really important too, like Jamie said, to go through it, look at it, and make sure that this is a very fluid dynamic forecast that we're looking at. Again, something that you can model is something you can change, not just writing on a piece of paper and trying to figure it out. Otherwise, it will drive you pretty much batty. So with that forecast, once you've identified the revenue over the next three months and you've got to look and see how is that really going to impact cash. Is cash still okay? Do we still have that 10 percent reserve, or are we getting to a point where we really have maybe one payroll in the bank or something that's a little more scarier? As a business owner you have to kind of look at the cash impact it immediately has. So then at that point, if we're okay with that impact, then we look at the dynamics of how this is going to end. You know, are we going to end up being now in negative 5 percent, or negative 10 percent, because of the big hit here? That's really not acceptable. So if that's the case, then we have to really do a lot of juggling of different areas. So when we talk about the areas that we focus on we look at the two big ones, which would be your gross profit margin and then your overhead. Your overhead consist of the facility, marketing and admin costs. And we typically want to see that, again, the overhead total which also includes, mostly, owner salary at that 35 percent mark, no more than that. Then on the production side, we want to see that about the 15 percent mark, and really no more than that. Which leaves that 15 percent net income. So we want to build our model back to the 15 percent net income. So going through this, if we decide hey, we're going to lose, maybe two of our big clients, that's going to really put a big damper on things on the net income, and takes us from a projected 20 percent down to 5 percent, or maybe zero or whatever that percentage might be. Then we need to look and say okay, now what do we need to cut, or need to reduce back, or what do we need to control more on the expense side? The first place you look obviously is at your production side. Do we have too many producers at this point that can manage a lighter load? And it might come down to well, I don't know. It’s now like I have that crystal ball. I don't know. So what do I do? Well, unfortunately you have to look back on how much cash you have. If you have a lot of cash, you've got the luxury at this point to kind of wait it out a little bit and see how things kind of shake out. If you don't have cash then you don't have that luxury. You've got to make some really tough decisions on how you can come back. How can you scale back your team so that you’re back at that balance there, not 50 percent gross profit margin. So it might be cutting back a couple of your developers, designers, whatever might not have as much impact on your overall product. And that's a good time really to kind of scale back and look and start re-evaluating your team. Who are the people that really aren't cutting it? You know, maybe I need to let that person sit on the sideline for a little bit, maybe bring them back after this all shakes out. You know, that type of thing. It's just it's a revision, basically you are revising your forecast. And the important thing is, I want to stress, don't revise it to zero or a very small profit margin, because you're very rarely going to hit that. So you want to make sure you revise it to something that after this year is over you can say, well, that wasn't too bad. I've made that adjustment. Now, maybe it's 15 percent or twelve percent or 20 percent if you're used to a higher profit margin now. So make sure that you come back to reality with that profit margin. Don't just accept a 10 percent, or 5 percent profit margin. You know, what can I do to rebalance? And typically it's the production. But once you do all your calculations and you find out that, well maybe my overheads a little too high. Well, you're part of the overhead. Maybe cut your salary back a little bit to bring it in. Or if you find that, hey, we don't need to be spending as much in marketing, or we don't need to be spending as much in admin, maybe it's time to cut back some of your admin and marketing costs whether that is an admin person or, different things that generate your business. You've got to really kind of keep re juggling your plan to come back to reality. You know, come back to that 15 percent. And you know, the companies that I think are really going to come out of this strong are the companies that actually do this. You know, they don't just let things happen, but they really do truly focus on how can I make my company not exactly where I was before, because that's going be tough, but make my company end up with a pretty solid overall year.
Jamie Nau: Great. So I think what I'd like to do here, I think this might be an interesting way to talk through this is, why don’t I walk through with you what I did with one of my clients as an example. Then you can kind of like chime in on things that I'm talking about, and give a little bit more context. I think that might be a really helpful way for us to walk through this.
Jody Grunden: Great idea.
Jamie Nau: So the client I'm thinking of is a client that traditionally has about 30 percent of revenue in the bank. So they're usually really good on their cash reserves. In January, they paid some pretty large bonuses, and they paid out the profit sharing out in January. So their cash reserve was still good, it was still around 20 percent. But this is a company that's used to carrying close to 30 percent cash reserves. So that's a little bit of baseline of where this company was at in terms of cash when this whole coronavirus hit. So that's just a starting point. So with the way I look at that is obviously they have enough cash in the bank to wait and see a little bit. From an ownership standpoint, he is a little impatient because he's used to having 30 percent in the bank. I was a little nervous, but he was agreeing that we could wait a little bit in terms of what the next three months were going to look like. The first thing we did was we looked at their existing contracts. So we looked to all their existing projects and let's say there were 12 of them. We walked through all 12 of them one by one and said okay, have you had any conversations with client 1? Have you had a conversation with client 2? And after we did that, they had conversations with all their clients. There were two clients that we knew for sure were ending. There were two that we were a little worried that they were going to pause services on, so we documented that. Basically for the two we knew were ending, we took those out of the best case scenario. For the two that were possibly ending, we left them in the best case scenario, but took them out of worst case scenario. And so we built a scenario based on their existing projects first. So any thoughts or context on that Jody I should add? Does that makes sense?
Jody Grunden: No, that's great. You broke it into three different buckets, or two different buckets, whatever many different buckets that you needed to do to bring out the fact. That's exactly what I would have done.
Jamie Nau: Okay, great. So the next thing we did was we looked at our pipeline, so we looked at our pipeline and we went project by project and said okay, how do you feel about these projects? And what we did is we identified the ones that we feel might close in the next three months. Everything else, we threw out the door so can we talk about those later. I'm only concerned about the ones that will close and you'll earn revenue over these next three months. Then for all of those pipeline projects we basically said okay, what do you think your chances are of winning them? High, medium or low? Anything that was high, we started with all of them. So we put all of them in the best case scenario, high, medium or low. Every one of these projects were in the best case scenario situation. Then we created that middle realistic case scenario where we pulled out all of the low cases. So anything they thought that they really didn't have a good chance of winning, I pulled out of that realistic case, and then I created a worst case where I pulled out the ones where they identified as we could really well win these, but I'm not certain that those. So basically after I had that, I had three different buckets of revenue for the next three months. I had my best case scenario, assuming we closed everything and we don't lose anything but the note, the ones we know we're losing. I have my realistic case, which is we know we're going to close these because we feel very confident and we've had conversations with them. The medium ones, we hope we win, but we're not certain on yet. Then the worst case scenario had those low ones in there which could close the next three months, but we're not feeling great about. So I kind of had three scenarios of revenue for the next three months of what they could look like.
Jody Grunden: Now how did you include, like the bohemian clients, like the big million dollar deal that doesn't come around very often. How do you include that into your buckets?
Jamie Nau: Yes, actually, they had a handful those, and so I really just pressed them on it. I said okay, you know this million dollar project, obviously now we're going to win it, but how much revenue is that? How do you how do you feel about it? They said, yeah I think we're going to win it. I'm like okay, if you do win it, how much revenue could you get over these next three months? So I didn’t put all of that revenue into the next three months. I only took the portion that they're going to earn over the next three months and put that it in there. But this company had a really good sense of their pipeline, and if they don’t, what I would have done is, I would've said hey go make some calls, go have some conversations and let's meet tomorrow, or let's meet the next day, because I don't want them going into this conversation doing a lot of guessing because that makes it a lot harder to have. So luckily when I had this conversation with the client they were really aware of what was going on in their pipeline and what each of those projects meant to them. Make sense?
Jody Grunden: Oh It makes complete sense. So what do you do next?
Jamie Nau: So after that, what I did was I had three revenue scenarios for them. So what I did to that is, I took their expenses, as they've existed in the past as we were forecasting, and I compared them to next to all three of those scenarios. Obviously the best case scenario resulting in some pretty strong revenue for the next three months. It was resulting in 30 percent profits, cash was growing, and these next three months are going to be really strong. Our realistic scenario was a little worse than that. It was closer to 10 to 15 percent. For a company that's used to earning 20 percent, obviously that wasn't great for them. They weren't they weren't too excited about it. But considering they had a cash reserve in place, and they were a pretty strong company over the last twelve months, they were okay with it, not great with it. The worst case scenario was a break even, or a loss over these next three months. So that freaked the company out. They didn't love that example. So what we did is for each of those scenarios we kind of talked about what cost savings we could have. Best case scenario, just keep doing business as is. We can handle 30 percent profit over the next three months if that's what happens. Middle case scenario, realistic scenario, let's try to get that 15 percent to a 20 percent. So what they decided was they had a couple of production employees that were contractors that they were paying to do projects where they probably could replace those contractors with full time people they already had on staff. Save the cost and get closer to 20 percent. So that's what we decided. If we are in this realistic case scenario, then that's what we would do. We would remove those contractors and replace that work with more of the employees that are here long term. That was the realistic.
Jody Grunden: So sounds like basically what you did is you were planning for the different scenario. So you're not just taking one scenario and saying hey, the sky is falling, let's let all our people go because we're going to have a horrible next three months, because you really don't know that. But you did basically base it that scenario. If we did have that scenario what would we actually do?
Jamie Nau: Exactly.
Jody Grunden: Now we're going to do these X, Y, Z, these things. Then you also did the same thing on the on the best case scenario. If everything goes really well, here's what we're going to do. We're not planning necessarily for everything to go well, but we're still going to do scenario planning. You know, right now we're not in in the worst case scenario, or not the great scenario, we don't know. And maybe the middle scenario is where it ends up. So I think what you're doing is you're trying to teach the client that hey, you've got to have an outlook on all three scenarios. You know, here's how we manage this company if this happens, here's what we do if this happens.
Jamie Nau: Exactly. Yeah, because like you said, in the worst case scenario, that was even worse. It was getting rid of contractors, and they had three or four employees that they were developing but weren't quite there yet and they weren't exactly working out. And if we were in that worst case scenario, we'd have to let those people go. And exactly to your point, I think the best thing you can do during these rough times is be prepared to pull the trigger quickly. So what we did is once we had this built, we just sat back and waited, and every week when we met, I asked okay, anything changed? Let's look at the best case, realistic case, and worst case was there anything triggered that happened. And honestly, what happened with this company, luckily, is a lot of those deals that were in the low started signing. They started signing some of these low deals. They started signing the medium deals. So we were leaning a lot more towards the best case scenario where they didn't have to do anything. Where if I met with them in week two and they said well Jamie, these two medium deals didn't sign that we thought we're going to, we probably have to start talking about okay it’s probably time to start having these conversation with those contractors right now instead of deciding that at the time those decisions were already made. So you can react very quickly. If that would have happened on a Monday, and I was going to meet with the client on Thursday, and he couldn't get a hold of me for some reason, he could easily make those decisions. We talked about if these two deals don't sign, you're going to have to get rid of your contractors. So he could have done that without even talking to me as a CFO. Again, I want them to call me. I wanted to Slack me. I want them to get hold of me, but the biggest thing is being prepared to act quickly, which most companies that don't do forecasting aren't prepared to do.
Jody Grunden: So you basically took the emotion completely out of the decision making process, which a lot of people fall guilty into that, especially when things really start happening with the closures of businesses, and with the quarantining and all that, people just you know, clients are like oh, my gosh, the world's coming to an end. What do I do? Do I let everybody go? What do I do? And it's more or less just sitting down and kind of going thorough that forecast and kind of showing them what Jamie was saying, building each scenario out, saying hey, we're not in any of these three scenarios that yet. You haven’t list a client yet. You may never lose a client, and they are like, we are going to lose a ton. Then they start rationalizing why they're going to lose a ton, and why things are going to go where they are, just like people do on the opposite side. Hey, we're going to we're going to win every deal. You know, you get the opposite effect too with people. So you kind of got to sit down and take that emotion out, and just go to through the scenario planning, Well if you lose everybody, here's what happens. Let's go through the scenario planning where you start picking clients up. You know, here's what happens when you do that. When you go through that scenario planning you really do take that emotion completely out of the picture, and you kind of sit back and kind of relax a little bit, knowing that, hey, yeah, I guess, you know, even if things do go bad, if you plan it out, we can still make it through here without a problem. It's not going to be the same exact company that we started with, but we're going to have a viable company. It's going be a company that is going to continue on year over year, which is very, very important.
Jamie Nau: Yeah, and I think the other part of it too that was great was having someone to have these conversations with. Again, if you don't have a CFO maybe pulling in your ops person, or pulling in other people in the business to have these conversations, it's crazy the ideas that come up. Having a one person conversation, just sitting there with a spreadsheet is going to be all your thoughts. But having someone to talk to about really helps. I'm using a different company here, but for one company I did this exact same thing that I was talking about. They had a little less cash situation in place which was a little bit more difficult. But one of the things he brought up right away was, let's look through our expenses in detail, and we were able to pull out all of their meals and entertainment, all of those costs that they were spending on keeping the kitchen stocked in the office, all of their rent costs. They got rent forgiveness for two months. We were able to plot some of those costs automatically because we knew they weren't going to happen over the next three months. And so that that made all three scenarios look a little better. And we didn't really have to go down the person cutting lane yet, unless we got into that worst case scenario. So it's great to have multiple people in on this conversation because more heads are better than one. You know, we're going to think of lots of different ideas on ways to save costs.
Jody Grunden: Yeah, and now how do you take into consideration clients qualifying for funding for the PPP loan? How do you take that into consideration? What are you telling clients?
Jamie Nau: So we built that into the best case scenario. So early on when we started these conversations, we didn't know much about these PPP loans. We knew that the application process was going to happen. We didn't know exactly how much was going to be forgiving, but we knew companies would qualify. Once we started knowing more, we started moving into the different buckets. Maybe we moved it from the worst case into the middle case. But the important thing when you're doing that is you have to be forecasting the balance sheet as well. So I wouldn’t just throw it in the income statement say, oh yeah, we're going to get a $400000 loan in February, or March or April, whenever that came through.
Jody Grunden: If anybody got it in February, raise your hand.
Both: Laughing [in audible]
Jamie Nau: So I had just thrown it into one month of outlook, that obviously would affect that month's income statement, but you wouldn't know what it would do to your balance sheet. So you have to throw it on the balance sheet and say okay, if we get a $400000 loan on April 30th, how is cash going to look in each of those months? And so I could say, okay look, I'm going to have a million dollars in cash in April, and now it's to be $800000in May and then it will be down to $600000 in June, I can handle that. If I don't get that loan, obviously it's going to be a lot tighter. So it's about forecasting the balance sheet, like we’ve talked about before.
Jody Grunden: For sure, and like Jamie said, we tell people you really need to build that into your forecast, but don't build it into all three, because you have the worst case scenario until you actually have the money in the bank for those loans. Even if you're approved, until you have money in the bank don't spend it. You know, that's something that's really, really important to understand and remember. Even though the banks say hey, you're approved, you don't spend that money until you actually have it in the bank. Once it's in the bank, then then you basically just move from worst case scenario. Now that's not worst case scenario anymore. So, again, I think what Jamie would probably say well we go back and we have three more scenarios now. Here’s the worst case arose out of this one. What's the middle? What's the best? And continue that whole process until you're completely out of the woods. But over those next three months, it's going to be really important that you take full advantage of that loan if you get it. If you get it make sure that the money is being spent towards employees. Make sure that you're tracking those expenses. Make sure that you've got, you know, the other 25 percent going to the rent utilities, an interest, mortgage interest, that sort of thing. Make sure that's being documented well so that you can take full advantage of that when it comes out of the cycle. Keep in mind, if you lose employees during that time you're not going to get as much forgiven as you would maintained your employees. So it's important to understand how the loan actually works, because again it is a loan until it gets forgiven. So keep that mind when you're going through it. It's not free money until it is actually forgiven. So make sure you meet all the qualifications for it.
Jamie Nau: Yeah, I think that's a great point. I think if you're listening to this podcast, you're already very involved in your business and invested in your business. I think taking a couple extra steps to research debt forgiveness is important. I know the banks have come out with quite a bit of guidance on it but all of the official guidance isn't out there quite yet. But again on what that forgiveness is going to look like, you need to calculate it to make sure you get the most forgiveness you can. Obviously if you thought you were going to get rid of half your employees and still get full forgiveness, you need to think through that a little bit more. Maybe adjust your plans and say okay, we still need to cut costs, but every employee costs we cut we're going to get less of this forgiveness. Or maybe we need to think about some other things, we can cut costs on because every employee you cut is going to decrease that percentage you'll get forgiven.
Jody Grunden: Or maybe you're on the opposite side. You think hey, do I want to bring on somebody, maybe a contractor, bring them on as an employee, you might as well. You're going to get some benefit for it where the government will we or basically pay that for you for the next eight weeks. Take advantage of that opportunity too if you're in a situation where you're in a potential growing stage, or increasing staff, whatever the reason, you definitely should take advantage of it for sure.
Jamie Nau: So I am going to through our email address out there. You can reach out to us for podcast topics. You can reach out for us with questions, especially when it comes to this PPP loan and the CARES Act. We've been doing a lot of research on it. So if you want to reach out to Jody or I to get that information our email address is: firstname.lastname@example.org. Again, the email address is: email@example.com Reach out. We really don't mind helping people through these tough times, answering questions like we are doing for all of our clients. We have a lot of answers at our fingertips, so feel free to email us. Then as always, if you have any topic recommendations for us, or you want to be a guest in the show, you can e-mail that account. So any final thoughts, Jody?
Jody Grunden: I would say in closing here, looking at this as an opportunity, I think is the way that you really need to look at this whole thing. It is truly an opportunity for you to right size your ship. It's an opportunity for you to really dig in and make sure that, you know, your business is going as well as it needs to go, and if it's not, cutting the fat at this point so that it brings it back up. So I think, you know, a lot of companies are going to come out of this very strong. Even if they do have a big hit in sales, sales isn't the driver there, it's the net income, and what you can bring to the bottom line with the cash, you know, that's the key to it all. So I guess do your inner thinking, your inner works. Look at your business as a whole. Find out what you can do to make sure that even though you go through this, you don't miss a thing on the bottom line. That you still have that 15 percent bottom line there at the end. I think you're going to come out of this, it’s going to be tough, but I think you will come out of this doing pretty well.
Jamie Nau: I that that is a great closing thought, Jody. I think people are very stressed right now. There's a lot going on both in our work lives ,and our personal lives that make it a lot harder. So I think taking this time to build your business stronger is going to make future times like this a little less stressful. So I think it's a great tip. I definitely would recommend taking the time right now to evaluate your business, because once you do, once you have those conversations, once you have those thoughts, it will be amazing what you find, and what your business is going to look like in the future. So great, great tips there. Well, thanks for joining us today, Jody. Hopefully the listeners enjoyed this topic, hopefully it was helpful in these times right now.
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