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Building a Better Budget, Part 6: Projecting Cash Required for Expenses

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SKILL SETS: BUDGETING

Building a Better Budget, Part 6: Projecting Cash Required for Expenses

by Marion Gropen

Publishing companies are more vulnerable to cash-flow crises than most other types of businesses. And most of the strategies you can employ to avoid them require time, which means you need to project your net cash position for each month for at least 12 months into the future.

Earlier articles in this series have discussed the process of building a budget and ways to project your cash inflows. You also need to project your outflows, and that’s what we will tackle now, starting with the largest chunk—cost of goods sold (COGS)—and covering other types of expenditures, ways to compute your net cash position, ways to spot trouble coming, and possible strategies for avoiding it.

Cash Outflow: COGS

In most businesses, you need to invest in making your product before you can sell anything. The book business is no exception to that rule, although the time between investment and return may be long, and the size and predictability of the profit may be low.

There are three different kinds of costs of goods sold (COGS) in book publishing, but we predict the cash spent on them in four ways.

The three kinds of COGS are:

• royalties

• “plant”

• paper, printing and binding (PPB)

Royalties and PPB need no definition, but the term plant costs means something different in the book business than in the rest of the world.

To us, it means all the fixed costs of producing an edition. In other words, plant costs are those for which the total expense does not change when the number of copies sold or printed changes. Examples include costs for cover design, editorial expenses, and proofreading.

We predict cash flows out in these four chunks:

• Royalty advances, because they can be large, and they’re on a relatively

predictable schedule.

• Plant costs.

• PPB.

• Royalty earnings, because they’re potentially quite large and because predictions for

them tend to be moderately complex. Also, since most publishers pay royalties only

 

a couple of times or a few times per year, these payments can severely disrupt
cash

flow, even when the amount per title is small.

Royalty advances. Royalty advances are generally paid in several pieces, such as one third on signing, one third on manuscript acceptance, and one third on publication. If you have already signed a book, and it’s on your publication schedule, it’s relatively simple to project your cash requirements for that title.

Of course, publishers also acquire books throughout the year to keep their pipelines full, and no one knows quite when the perfect manuscript may come through the door. I recommend that you follow one of two ways of dealing with the uncertainty. You can allow a certain amount for acquisitions each month, or you can look at your acquisition editors’ schedules. There are months when they are insanely busy preparing for sales conferences and the like, and then there are months when they are more apt to be out hunting for promising books. You probably should bump up the allowance for advances in the months when the editors are beating the bushes.

In general, your royalty advances should be about half the royalty expenses you expect from the books you are signing. So if your pipeline takes two years to pump out a normal manuscript, look at your desired sales for the year after next, multiply that number by the royalty rate you are offering, and divide those royalty earnings in half. The answer is your budget target for royalty advances.

Very wise CFOs will add in a lump sum to allow for editors’ inevitable overoptimism (without letting the staff know they’ve done this). We are in this business because we love our books like children. Most editors have trouble being objective about the sales potential of their “babies.” If your editors get better at calculating the advances, there will be other things that go wrong and other places to use funds allocated to cover overoptimism.

Plant. After you’ve done a few books of a certain type, you can predict quite well how much design, copyediting, layout, and so on will cost. You probably also have a production schedule for every book you’ll be publishing in the next year. Use that production schedule and your expected costs to build a spreadsheet that looks something like this:

Obviously, you may be paying some fees on completion and some up front, so you may need more than one date per task. Similarly, you may need to pay for greater or lesser amounts of outside work, or even none at all.

You don’t need to schedule payments to in-house personnel in your cash-flow budget, although they may well be assigned to plant costs for tax or other financial analysis and reporting purposes. It’s easier to include them in the forecast for salaries later in the process.

Once you have your production schedule and your payment schedule for all your planned titles, you can make a month-by-month spreadsheet for plant costs that posts the payments above into the appropriate month. And then you can feed this into your summary spreadsheet.

PPB. Some companies print digitally. Some print offset and only one run. Some issue only e-books and don’t print at all. Most of us use a mixture of formats and processes. Whatever your printing practice may be, you need to schedule runs in relation to your predicted sales patterns, and then project the payment in full when a printing is done. (Some printers require partial payment up front from some publishers, but it’s unlikely that a print run will take more than a month, so both parts of that payment will fall in the same month more often than not.)

It’s tedious, but not complex. When you’re done, feed this too into your summary spreadsheet.

Royalty earnings. This is the most complex part of forecasting for cash outflows. Fortunately, there are two ways to tame its complexity.

First, you can use averages to project royalty payments based on sales and past history, assuming that your future titles will earn out at the same rate as past titles have done. If any book looks likely to behave in a massively different way, you may need to adjust your numbers to take that title into account.

Second, if your company is small and you have only a handful of active titles, you can use one of the industry-specific software programs to calculate the royalties due for all projected titles, based on your projected sales. Most don’t offer a budget option, but you can set up a dummy company in the program, plug in your budget sales numbers as if they were real, and pull out royalty reports.

When you calculate the average rate, make sure you look at the same type of number you used in the forecast. Your numbers won’t be accurate if you used sales at list to calculate the average rate, and then applied that rate to sales net of discounts and returns.

There’s another common error to avoid. The royalty rate in the contract is not the rate to use here. That rate specifies the amount that authors earn, before you apply the advance. You have already calculated the cash-flow impact of paying advances elsewhere.

To get the necessary average rate, look at the amount of sales in your income statement in each of three or four different prior royalty reporting periods. Net out all returns, and discounts. Now add up the total royalty payments made for each of those royalty periods. Divide the payments by the sales. That number should be very nearly the same for each period. If it is, that’s the average rate you use.

Now sum up the sales for each of the royalty periods in your budget year, and apply that same rate to them. This is the cash you can expect to pay out to your authors in those periods. Enter that payment in your summary sheet in the month it will be paid (not in the month it will be earned; that’s one difference between accrual accounting and cash accounting).

Cash to Marketing and Ops

The cash-flow impact of sales and COGS is often felt before or after the month in which those items show up in your income statement, so you need to do an offset in your cash-flow budget. The rest of your expense lines are usually much simpler, for which we can all be thankful!

Copy the monthly total expenses for marketing and for other operating expense categories into your cash-flow projections. At this point, add back into the salaries and benefit lines anything you might have included in plant expenses on the income statement. As noted above, we did not include them in the plant payments for your books.

Gaps in Cash Flow and How to Avoid Them

Now that you have estimated how money will flow into and out of your company, it’s time to assemble an overall picture. Your summary sheet might look like this:

N.B.: Remember that we’re rounding to the nearest thousand. Some additions and subtractions will look wrong when they’re not. But you should always keep an eye out for errors and check anything you’re suspicious about.

As you can see, above, our hypothetical company started with a significant no-interest loan ($65,000, probably from family or friends), the proceeds of which funded the development and launch of its first two books. The company also started with a certain amount of working capital contributed by the owners, because significant cash investments were required beyond the amount of the loan before this year opened. In this budget, it has covered that loan and managed to scrape together enough cash so that, with care, it may be able to develop the following year’s titles.

As you can also see, the company has already arranged things so that there are no cash-flow holes to fill.

Using Cash-flow Graphs

Graphs convey things to most of us that pages of numbers never will. Accordingly, it’s important to graph things like the total cash flow, or the net cash position of the company.

This graph shows not only the total cash flowing in and out, but also the operating cash flow out (operating cash flow in this case excludes the debt service). This makes it clearer that the flows in and the operating flows out do not coincide. Fortunately, the total cash on hand is never negative, and no emergency measures are needed.

You can also see that the outflows increase at year’s end. That reflects the production of books for release the following year and signals that the company must be careful to ensure that the cash reserves are sufficient to carry it through that period, even though the period is outside the 12-month budget period.

There are other reasons to look at graphs like this. For instance, if your company planned to pay a big advance for one book at the same time as you were doing a big marketing push for another and paying for the print run on a third, you might miss the common timing in a spreadsheet. On the graph, that jump in cash outflows will be obvious. Then you can go looking for the cause, and make adjustments if necessary.

Steering Clear of Crises

Once you have identified an approaching cash gap, you need to identify responses that will avert the difficulty. The simplest solution, but generally not the easiest, is getting an infusion of outside cash.

If that is not possible, what are the other options? They include adjusting the timing of your releases, the production values planned for the books being released, the distribution channels or marketing you will be using for the books that will be selling at that point, or your overhead requirements for that time period.

Sometimes you can simply publish a “big” book earlier or later, and thus move the expenses entailed in producing it by one month, or even two or three months. That may well be enough to make all the difference.

If that isn’t going to make your problems disappear, you may need to change the way you are producing, distributing, and/or marketing your books.

Perhaps you can make the books that are bringing in money during that time period bring in more money. But generating more sales may well require increasing expenses for editorial or design or marketing (or some combination of them) in the earlier months. You’ll need to evaluate whether that is possible, or wise. Then you’ll need to check to see if it alleviates your problem.

Or perhaps you can cut the production expenses for the books that will be in the pipeline then. But cutting the costs of producing a book almost always means that you’ll also have to cut your estimation of the sales it will generate. This is likely to create more problems in future time periods. It will need to be carefully evaluated against all your other options.

Maybe distribution expenses can be pared. Adding distribution channels or switching partly or entirely from one to another can make a huge difference not only to final profits but also to the timing of the payments. Is one of your books a candidate for such a switch? Is a whole line of books susceptible to it? The question may be worth asking even if you do not have a cash crisis looming.

The final resource of CFOs looking for ways to make the checkbook balance is cutting overhead. This means finding ways to cut payroll, benefits, rent, utility bills, office supply expenses, and all the other items that you see on any business ledger. You could, in an emergency, furlough or lay off employees. This is a dire option to be avoided if at all possible. But moving to less expensive quarters, offering employees the option of working from home, turning down a thermostat in winter or turning one up and opening a window in the summer all offer the possibility of cutting costs.

Cutting overhead without cutting efficiency or morale is difficult, but it can pay off well. If you can cut $10 from your office supply budget each week, that will have roughly the same effect on your cashflow as selling 500 more books per year. Not a bonanza, of course, but not trivial.

Marion Gropen consults with micro- to medium-sized publishers on financial and operational issues and offers consultations by the question for smaller publishing companies. She recently published the first part of her e-book series, The Profitable Publisher. To learn more, visit GropenAssoc.com. You can reach her, with questions about this article or other publishing issues, at Marion.Gropen@GropenAssoc.com.

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