Your Agency Made a Profit. Did It Make the Cash? How a Buyer Checks Cash Conversion.

By Craig S. Cody, CPA, Certified Tax Coach.

Here's the answer up front. Cash conversion is how much of your profit actually lands in the bank, and how fast. A buyer checks it because they're paying a multiple of profit, and profit that never turns into cash is worth a lot less than profit that does. For most agencies, cash gets stuck in four places: slow receivables, billing at the end of a project, media you paid for before your client paid you, and unbilled work that keeps growing. Fix those with billing discipline, measure days to collect every month, and you'll have an answer before anyone asks.

When we go looking for an agency's missing cash, we typically find it in a few places. For owners who pay tax on the cash basis, it shows up in the accrual to cash adjustment, because receivables are growing. Sometimes it's larger than normal owner distributions (that gets added back, because it's real cash). For those paying tax on the accrual basis, it's receivables that keep growing. And sometimes we find income that wasn't allocated to the period when the work was performed, so the matching expenses aren't included. A buyer will look in the same places.

What Is Cash Conversion?

It's your cash from operations divided by your adjusted EBITDA, for the same period. One common way a buyer looks at it, and the simplest.

Here's an example with made-up numbers. Say your agency shows $600,000 of adjusted EBITDA for the year. Over the same twelve months, the business generated $420,000 of cash from its operations. That's 70% conversion. The other $180,000 of profit is real on paper, but it's sitting somewhere other than your bank account.

The question isn't whether the number is 100%. It rarely is, and a growing agency will often run below it, because growth ties up cash. The question is whether you know where the rest went, and whether it's coming back.

Why Does a Buyer Check It?

Because the gap between profit and cash is one of two things, and the buyer needs to know which.

The first is timing. The cash is coming, just later than the profit. A big client pays in 75 days instead of 30. A project gets billed in March for work done in January. That's a working capital question, and a buyer can live with it once it's explained.

The second is profit that was never real. Work in process booked at more than it'll ever bill. Invoices sitting in receivables that nobody expects to collect. Income booked in a period without the expenses that belong with it. That isn't timing. It's profit that has to come back out of the number the buyer is paying a multiple of, and it's why accurate receivables matter so much. Who decided that invoice was never getting paid? covers the policy side.

An agency that can show the gap, month by month, and explain every piece of it is in a very different conversation from one where the buyer's accountants find it first.

Where Does an Agency's Cash Get Stuck?

Almost always in one of four places.

1. Slow receivables. Invoices that sit 60 or 90 days because nobody follows up. The profit was booked the day you billed. The cash shows up whenever the client gets around to it.
2. Billing at the end. A four-month project billed on delivery means you've paid your team for four months before you see a dollar. Your P&L shows the profit along the way. Your bank account doesn't.
3. Media float. When you buy media for a client, the platform often wants paying before your client pays you. Those aren't your dollars, and they don't show up in your agency gross income (AGI, your revenue after pass-through costs like media and production), but the cash to pay for them still comes out of your bank account. Fronting a big client's media for 45 days can tie up more cash than a month of payroll.
4. Growing work in process. Work you've done and haven't billed yet. It counts as profit in accrual books, and it's often legitimate. But if it grows every month, something in your billing is late, and a buyer will ask what.

Each one is a timing problem until it isn't. A receivable that's 30 days late is slow. One that's 200 days late is a write-off nobody has made yet.

What About Owner Distributions?

They're one of the first places we look for missing cash, and they're a separate question from conversion, so it helps to keep them separate.

Distributions to owners don't make your cash conversion worse, because the buyer measures cash from operations before distributions are paid out. But they do explain the year a buyer is most likely to ask about: the one where profit went up and the bank balance went down.

If that happened because you took a large distribution, say so, and show it. If it happened because of slow receivables or fronted media, that's a conversion problem, and it's better that you're the one who found it. The worst answer is "I'm not sure," because then the buyer's accountants go looking.

And if personal expenses run through the business, they muddy both numbers at once. Those come out as add-backs, which Clean Books Sell Agencies. Messy Ones Get Discounted. walks through.

How Do You Measure Days to Collect?

Take your receivables at month end, divide by what you billed over the last twelve months, and multiply by 365. That's roughly how many days, on average, it takes to turn an invoice into cash.

One detail that trips agencies up: use what you billed, not your AGI. Your receivables include the media and production you billed through. Divide them by AGI and the number looks worse than it is. Divide them by billings and you're comparing like with like.

Then track it every month. The number itself matters less than the trend. A steady 40 days is a business with a rhythm. A number that creeps from 35 to 60 over a year is a story a buyer will want told.

How Do You Turn More Profit Into Cash?

Mostly with billing discipline. None of it is complicated, and all of it takes time to show up as history, so it pays to start well before a sale.

• Bill retainers in advance. Invoice on the first of the month for that month's work, not at the end. That one change moves a month of cash from them to you.
• Bill projects in milestones. A deposit to start, then billing at agreed points along the way. Your client knows what's coming and you're never four months out of pocket.
• Get media paid before you pay for it. Bill media in advance, or set payment terms that match the platform's. If a client wants you to float their media, that's a financing decision, and it should be priced like one.
• Review receivables on a schedule. A slow payer gets a call while the invoice is still young. Anything that won't be collected gets decided on purpose. My own rule on timing is simple: there's no rush to write off an invoice or issue a credit memo, and a regular review of receivables makes the decision a blip in time.
• Watch work in process. If it grows month over month, find out what isn't getting billed and why.

Recurring revenue helps too, because a retainer billed in advance is about as close to perfect conversion as an agency gets. Not all agency revenue is worth the same to a buyer is the companion piece on that.

Who Is This Not For?

If you're years from any sale, you're not on a deadline. But cash conversion isn't only a sale number. It decides whether you can make payroll in a slow month, hire before the work lands, and take a distribution without worrying about the next one.

And if your conversion is low because you're growing fast, that's normal. Just be ready to show it, because "we grew" is a good answer when the numbers back it up.

What Can You Do This Week?

Pull last year's adjusted EBITDA and last year's cash flow from operations, and divide one by the other. Then pull your receivables at month end and work out days to collect on billings.

Two numbers. If the first is lower than you expected, look at the four places cash gets stuck and find which one it is. If you can't get either number in an afternoon, that's the first thing to fix.

What This Article Is Not About

Selling an agency is a big subject, and other pieces cover the rest of it:

• Whether your profit can be proven, and the add-backs a buyer makes: Clean Books Sell Agencies. Messy Ones Get Discounted.
• The twelve months before a sale, in order: the exit readiness calendar
• Forecasting cash with recurring revenue: Why Recurring Revenue Makes Your Agency's Cash Flow Easier to Forecast

This one is only about cash conversion: how much of your profit reaches the bank, how fast, and where the rest went.

Frequently Asked Questions

What is cash conversion for an agency?

Cash conversion is how much of an agency's profit turns into cash, and how quickly. A common way to measure it is cash from operations divided by adjusted EBITDA over the same period. A buyer checks it to see whether the profit they're paying for actually reaches the bank.

Why can an agency be profitable and still short on cash?

Because profit is booked when work is billed or done, and cash arrives when clients pay. Slow receivables, billing at the end of a project, fronting client media and growing unbilled work all push cash later than profit. Owner distributions also lower the bank balance without lowering profit.

How do you calculate days to collect for an agency?

Divide receivables at month end by what you billed over the last twelve months, then multiply by 365. Use total billings, not agency gross income, because receivables include the media and production you billed through. Track the trend monthly rather than reading one month on its own.

Do owner distributions hurt cash conversion?

Not the ratio itself, because a buyer measures cash from operations before payments to owners. But distributions explain why a bank balance can fall in a profitable year, so be ready to show them separately from any slow receivables or fronted media.

How can an agency improve cash conversion before a sale?

Bill retainers in advance, bill projects in milestones, get media paid before you pay for it, review receivables on a schedule and watch unbilled work for growth. These changes take time to show up as history, so start well before a sale.

Let's Talk

Your P&L tells a buyer what you earned. Your bank account tells them how much of it was real money. The agencies with a short answer to "where did the cash go?" are the ones that bill on purpose and look at receivables before they get old.

I also wrote a book for agency owners. You can request a free copy at the link below.

Craig S. Cody is a CPA, Certified Tax Coach, and retired NYPD Lieutenant. His firm works with more than 70 marketing and advertising agency owners every month, helping them keep more of what they make through proactive tax planning.

This article is general education, not advice for your specific situation. Confirm your own facts with your advisor before acting.