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Money Matters in the Creative Industry (Pt 2)

Just like other businesses, cash flow management is also crucial for a production company…

As mentioned in part 1 of this article, revenues need optimal costs to tango with before any profits can be derived at. Various aspects of production costs need to be managed up front in order for a viable decision making to be made.

Questions such as which director to hire? Who would do the scriptwriting? Profile of the cast; crew members selection; and many more. Typically, whilst the amount of time spent during pre-production is quite long, the costs incurred shouldn’t be too high. Pre-production activities that cost 10% of the entire production budget sounds fair.

Meanwhile, 50% of the budget should go to the actual production and the remaining 40% on post-production activities that include colour grading, voice overs, music, sound effects, editing and of course, Computer Graphic Images (‘CGI’), if need be. In the case of an animation, one would probably push more percentages for CGI.

Costs do not stop at pre-production, production and post-production only. One important element that must not be forgotten is Advertising and Promotion (A&P). Many producers make the basic mistake of not spending fairly on A&P. What is the point of having a superior product or services when the intended consumers are not aware of it?

There have been numerous examples of good content not achieving financial targets simply because of the reluctance on the producers’ side to incur marketing expenses

Benchmarked against various projects, a fair quantum of A&P would probably be at a minimum of 30% of the entire production budget. So, add up pre-production, production as well as post-production budgets and times that by 30%. That is your optimal marketing strength.

There have been numerous examples of good content not achieving financial targets simply because of the reluctance on the producers’ side to incur marketing expenses – movies, theatre shows or even concerts are known to be loss-making and most of the time it is because people (consumers) do not know of its (creative products) existence.

Foreign players have shown really good examples of how marketing can really boost their sales. Netflix is known to have rented huge outdoor billboards at strategic traffic locations so that they catch the eye balls that are intended for their programmes.

Netflix is naturally targeting urban consumers. As such, they have chosen locations such as the Sprint Highway or Lebuhraya Damansara Puchong (‘LDP’). Whilst digital advertising is the first choice of medium for urban advertising, nothing beats the traditional and hard core ‘In Your Face’ billboards.

 

Maximising revenues and optimising costs achieve profitability but it does not necessarily put us in a positive cash flow position at the right time. The timing of revenue recognition is never the same as cash inflows. Likewise, the timing of costs incurrence is never the same as cash outflows.

Cash collection from cinemas or even TV broadcasters can be late. In the case of cinemas, the box office collection normally requires weeks before a complete calculation is done to confirm the final numbers. When this happens, production houses will find themselves stuck in a situation where payments are due but cash is not yet in.

Producers often pay their crew members, directors and casting upfront. This causes cash shortages and disrupts all other production within the company’s slate of projects in a particular time frame. More care must be taken when that slate of production involves multiple productions that happen at the same time or significantly overlapping for a good portion of the production runs for the multiple projects.

Many Financial Institutions are somewhat allergic to creative businesses. Some would give loans but charge expensive interest rates as high as 12%

How do you then address that cash shortfall? For those with adequate cash, they will use their own money. Others may take loans from various Financial Institutions (‘FI’) although many FI’s are somewhat allergic to creative businesses.

Some would give (loans) but charges expensive interest rates as high as 12%. The financial facilities obtained from the FI’s need to be standby facilities whereby production houses should only draw the loans when production has been confirmed and locked in.

Having discussed the timing of cash inflow, we must not forget that the funding from the loans are meant to pay for the on-going production costs. When the actual revenue collection comes in, that cash must strictly be channelled back to the FI’s with the view of repaying back the loans drawn inclusive of the interest expenses that have been accrued on the loan amounts from the day it was drawn.

Many producers forget that they also need to pay fixed overheads. Not that they forget that they need to pay those costs but they forget to acknowledge that the profit margins from the various projects need to be enough to cover fixed expenses that recur on monthly basis.

When a potential investor asks, “What is your Burn Rate?”, it means that they want to gauge how much would you need as a basic before you can comfortably embark on the project itself

These are items that you will need to pay regardless of whether you have any projects in hand. Examples would be rental expenses, utilities, salaries of permanent staff, maintenance of equipment and of course, any interest expenses incurred as a result of loans taken to finance the company as a whole. The sum of all this is what investors normally refer to as the ‘Burn Rate’.

When a potential investor asks, “What is your Burn Rate?”, it means that they want to gauge how much would you need as a basic before you can comfortably embark on the project itself. A healthy business should already have enough cash balance in the bank to fund its Burn Rate for a minimum period of 3 months. In fact, many investors prefer a longer period such as 6 months to a year.

In 2013, a well-known American animation company, Rhythm and Hues, hired many Malaysians as their core workforce. They were big and highly skilled. However, given their Chapter 11 status (American bankruptcy regulatory status), the company had to be shut down leaving hundreds of staff unemployed.

Had Rhythm and Hues preserved sufficient cash for their Burn Rate, a White Knight might have been able to complete its due diligence in time to inject funds for the continuation of the projects in hand. It was a ‘Chicken and Egg’ situation. The staff wouldn’t stay unless they were comforted with salary payment and the investors wouldn’t come in if they were not comforted with project delivery commitment.

This demonstrates the importance of cash flow management. A company that records a huge profitability can still go bust when cash flow management is down the drain. The basic understanding to remember is that the timing of cash inflows must be adequate to cover committed cash outflows at the minimum rate of allowing continuous operations – a ‘Going Concern’ assumption.

The critical need to ensure cash flow viability warrants effective negotiating skills. Prices and timing of collection need to be negotiated with buyers. If the timing is prolonged, it is effectively suggesting that you (producers) are bearing the costs of financing on behalf of the buyers. This is because the ideal situation would be otherwise, i.e. Buyers drawdown loans with interest expense in order to pay producers. Hence producers would not have to take up loans to pay their suppliers.

The critical need to ensure cash flow viability warrants effective negotiating skills. Prices and timing of collection need to be negotiated with buyers

A healthy cash inflow level can be determined by ensuring adequate quantum, inclusive of some buffer, to cover production costs. Likewise the management of production costs, both incurrence as well as payment timing, will also need to consider the conditions of cash inflows.

The difference between revenues and costs is the gross margin. Gross margin needs to be enough to cover the Burn Rate (or also known as overheads). However, this is only possible if that is reflected in the excess of cash inflows versus cash outflows.

 

At the end of the day, the company must make a profit. All revenues less all production costs and overheads as well as interest on loans should leave behind residual as Net Profit that is worthwhile. If not, all the efforts will be put to waste.

The question is, “What is a worthwhile Net Profit?” A good measure for this is by comparing to other forms of profits. Had you invest the same amount of money (i.e. the sum of production costs, overheads and interest income) elsewhere, you would have earned a certain income such as dividends of 7% from unit trusts, or 3% interest income from a fixed deposit bank account.

In fact, given the efforts being put into creative production projects, that 7% benchmark would probably need to be added with a premium making it reach 10% or higher. Generally, as a rule of thumb, any business needs to achieve a minimum Net Profit margin of 10% to 15%. Otherwise, you might as well close the business and put the money into money market instrument that earn passive income without having to put in a lot of effort, or any effort.

Johan Ishak is managing director of Awesome TV

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