07 July 2019

Budgeting in the Creative Industry

By Johan Ishak
kopihangtuan.blogspot.com.my


BUDGET is a word many are allergic to. Budget ensures order. People naturally prefer to avoid order. They seem to cherish disorganisation rather than organisation. This is a big mistake. Order must be established. To ensure things are unfolding within an acceptable set of parameters, plan must be in place for which, implementations are guided. Planning consists of many components such as workforce requirement, equipment requirement, technological requirement and one aspect that cuts across is money. We need money to make money. In order to plan how to make money using money, we need a tool that can establish such order mentioned earlier. That tool is Budget.

The Creative Industry is no different from other industries such as agriculture, education, oil and gas, aerospace, manufacturing, automobile and many more. All of these industries have the same objective that is to make money. All of these industries put in resources in order to generate revenues. All revenues require proper pricing planning and marketing efforts. All input of resources require procurement of goods and services. In a nutshell, Budgets are important for any businesses. In fact, even if an organisation is not a business or a profit oriented entity, Budgets are still important. A country also needs a Budget. A school needs a Budget. A mosque needs a Budget. A criminal activity, if desired to be done smoothly, requires Budget. So what makes us, the Creative Industry practitioners, exempted from doing so (Budgets)?

How then do we budget for the Creative Industry? Firstly, we must understand the difference between the Statement of Income (or commonly referred to as the Profit and Loss) and the Statement of Cash Flows (Cash Flows). Profit and Loss is a measurement method to calculate whether the business is making profits or not. As long as a position is confirmed, a transaction is recorded. For example, if you sign a contract to produce a movie for RM5 million for a producer and you complete it, then that production work has earned its revenue based on the amounts agreed in the contract. However the payments for that revenue may have not occur yet. When the cinema collection comes in, then the payment may be made. So, in your Profit and Loss, you can record a revenue of RM5 million but in your Cash Flows, it remains as Nil cash inflow until the payment is actually done (in the future).

Similarly, when doing the production work, the timing of cash payments do not coincide with the actual performance of the work. You may have to pay some monies first before some work can be done or resources are utilised. For example, when you rent equipment, the equipment owners may want cash up front before you even start the production work. In this case, your Cash Flows are already recording an out flow of rental payments but your Profit and Loss has not yet recorded the cost of using the equipment. Some directors and main casts may want an upfront payment before they can accept any job. This will have the same timing effect between Cash Flows and Profit and Loss.

The nature of the Creative Industry in so far as cash flow management is concerned is tricky and risky. Many revenue transactions are only collected later and many cost transactions require early payment. If the gap between money in and money out is too big, with money out happening earlier than money in, we are shitting faster than we are eating. What happens when we shit faster than when we are eating? Well, we might shit out our own organs rather than digested food. If we do not manage this well, the net negative growth of coffers will reduce us to bankruptcy. This has happened and it has happened a lot. It is very important to have this in mind when we are negotiating with both our customers/clients and our suppliers. Our payment terms given to customers or clients must be higher or at least, the same as the payment terms that we get from our suppliers. If we are only getting paid 6 months down the road and we have to pay our bills and invoices within 1 month, then we ought to ensure we have enough money in the bank to foot the bills. This is what we call Working Capital management.

With this understanding, we must remember again and again that Profit and Loss does not necessarily paint an accurate picture of the state of our well being. There is no point being rich when our assets are all in property or land forms. We need some of those in liquid cash forms. A business may show a healthy profit number in its Profit and Loss account but it may also show a negative Cash Flows status at the same time. Although we can make plans for extra cash to be available but essentially, we cannot be worrying about quick fixing all the time as it will become a recurring issue - a cancer in our business. We must plan our projects diligently to ensure we do not fall into the trap of Working Capital deficiency.

How do we get the buffer in Working Capital to address shortfalls? Some people have money in their own savings. Many have sacrificed savings in order to continue business operations. Some has got good credit standing with the banks that are willing to give them loans in the form of term loans, working capital loans or overdrafts. Those with many projects can plan to ensure the payments for any particular projects are timed strategically to coincide with the timing of collection from earlier projects. Now, one thing we must not forget, when we are putting the business in a debt position, such as borrowing from others, there will be an extra item in both, the Profit and Loss as well as the Cash Flows. That item is Interest Expense (also known as Finance Cost) or Service Fees if it is an Islamic loan.

Naturally, when revenues are earned, that is when you charge costs to the Profit and Loss so as to match costs to its revenues. For example, when you have paid RM400,000 for a production of a Television (TV) series, you will only charge that into the Profit and Loss when you are certain that you will earn the revenue. In the case of a TV series, when are you certain that you have earned that revenue? Rightfully, this is when you get confirmation from the broadcasters that they have cleared and accepted your work fit for transmission purposes. Say, a TV station confirms the acceptance of your work and your production company was commissioned to do it for RM500,000, then you can now record RM500,000 as the revenue and RM400,000 as the costs, leaving you a profit margin of RM100,000. A 20% margin that is healthy.

Now let us see what happens to the Cash Flows while the Profit and Loss is already showing a 20% profit margin. In the Cash Flows, that RM500,000 will only get paid later subsequent to the TV stations confirmation of acceptance. This is because they will have to go through their processes in the procurement and finance department. Meanwhile, your production house will have to pay what is due to suppliers as production work for the TV series have been completed. Not all of the RM400,000 has to be paid but surely a huge chunk has to be paid. The trick now is to find the right timing of when the sum of cash collection and cash payments result in a net positive position. If not, you will have to adjust the timing of all projects in order to have a continuous net positive cash position. This needs to also take into account cash that comes in from loans as well as cash going out to repay those loans and their corresponding interest expenses.

A more predictive and reverse engineering method is required when it comes to laying down the future financial runway. Many parties feel that they need some sort of university degree to do all this. Mind you, even a university graduate who did bachelors in finance or accounting can screw this up. All you really need is common sense as far as matching the timing of cash inflows with cash outflows. All you need is diligence. All you need is to be street smart. All you need is agility and sensitivity to the daily dynamic unfolding of events. This is what it means to be an entrepreneur, especially in the creative industry.

Let us restart the thinking process to be more lay man in the comprehension of this all. Firstly, when deciding what to produce, we must have an idea of how much revenues that can be earned. Then, work backwards where you should gauge what kind of production costs are you willing to spend. This affects decisions on genre, casting, directors, crews, location, the extent of Computer Generated Images (CGI) and many other aspects of production and marketing costs. Do not forget that at this juncture, the revenue should be in excess of the production costs giving a Gross Margin estimate. As a business, entrepreneurs must decide what kind of Gross Margin is acceptable. You will need to consider how much is needed to cover Administrative Costs, Interest Expense, Taxes and other Overheads in order to derive a final excess we call Net Profit.

As a business, it is not just about revenues, production costs and margins. We must remember to maintain our office administrative resources that keep the office running. How many permanent staff are you willing to hire is a function of how much you are willing to pay every month with or without any projects in hand. This goes the same to the rental expenses, utilities and all other overheads. Interest expense was mentioned earlier. Typically, the business needs to put aside a sum of 7% of loans drawn down to pay for interest expenses as and when they fall due. This is when you will ask the question, “Can I afford to take loans?” If the cash flow is too tight, you won’t be able to pay both the principal portion and the interest portion of the loans. This will mean that you will need to consider other sources of funds. Finally, on yearly basis, you will need to put aside cash to pay income tax. Typically, income tax is at around 25% of Net Profit. Many production houses do not pay taxes simply because they do not make profits or they do not declare enough income to attract taxes. Whether this is done dishonestly or not, the right thing to do is to pay.

For a new production house, the initial years will be loss making years because the projects on hand have not yet reached critical mass. Gross Margins are still low. Meanwhile, the company needs to continue paying for their overheads or administrative costs that primarily consists of permanent staff and office rental. Over time, when the volume of projects increases, the Gross Margins from those projects should cover the overheads leaving a profit bottom line. The critical question then is, “How long can you endure operating at a loss before the business turns into profitability?” Business must make profit. If the profit is 7%, there is no point in running the business. Why? Because any Unit Trust, such as Amanah Saham Nasional, earns at least 7% dividend per annum. Therefore, your business should target an eventual profit of more than 7%.

Production requires money and time. Pre-production and post-production activities need to be factored into the business timeline. This is because, as mentioned earlier, the cash outflow will happen predominantly up front when there are no inflow in the initial years of the project. Even when sales can be made well in advance of the completion of production, the actual cash collection comes in later unless the model involves distributor financing arrangement whereby the distributors themselves decide to invest in the project. A healthy production business should have continuous multiple projects and again, what is critical is to match the timing of the cash in and cash out of all the projects. The benefit of having multiple projects happening in overlapping tracks is that cash inflow of a project can be the funding source for the cash outflow of another project. Mismatch between cash inflow and outflow in this portfolio management method can be a big problem and can jeopardise the ability to complete those projects.

As an entrepreneur, the production house must be willing to negotiate with the TV stations to reduce the risk of cash flow mismatch. For example, negotiating the payment term where the TV stations pay half of the contract value when half of the episodes commissioned are delivered rather than when full episodes are delivered.

At the same time, the production house should also negotiate with their suppliers for the equipment, casting, directors, crews, studio owners and many more so that payment terms can be looser spreading payments to a longer time horizon rather than heavy up front. For a more developed industry such as Hollywood, they even considered revenue sharing arrangements with the key people such as directors and main casting. This allows some minimum guaranteed (MG) payment up front and a percentage of revenue payment subsequent to the completion of the project. This helps ease the cash burden during the production stage and mitigates the risk by pegging subsequent payments to the performance of the sales. If the performance of sales is not good, in total, those key people will get paid less; hence, encouraging them to perform with the utmost quality in view of revenue sharing prospect.

In the case where the cash flow mismatch is inevitable, the critical question to ask is, “How to fund the production work when revenues are not collected yet?” Many resorted to borrowing the funds. This incurs interest. Interests in Malaysia for working capital funding of a creative business can be as high as 7% per annum. With such expensive option, we will need to ensure that we do not over borrow. An optimal amount of loan needs to be determined to ensure enough cash to sustain production. Sustaining production does not only mean to pay for the production but also to pay for administrative costs, overdue taxes, interest expense and more importantly, repay the loan. This brings us to another avenue for negotiation. You will need to negotiate with the funder on the loan structure. Variables such as duration of the loan, frequency of payment, revolving the credit facility or even go for a more equity type financing such as issuing Preference Shares where the repayment is deferred to a later lump sum transaction.

The cash inflow and outflow needs critical management. You do not want to face a very thin cash balance situation where heavy accumulated production costs and other costs paid but insufficient revenues collected. Cash balance may be thickened with borrowed money and eventually paid of progressively. Ideally, cash balance at the end of an expected project time line should be free of obligations to pay bankers and suppliers representing cash profit. To reach that state, you will need to endure a long gestation period of sustained business pipeline. For those who are fortunate, cash flow stress levels can be eased when you use your own money, Government rebates or grants such as those from Filem Nasional (FINAS) and as mentioned earlier, other lucrative projects that have been completed, delivered and paid in full.

Going back to the overheads or administrative costs, we must always remember that these costs are recurring with or without projects in hand. Generally, the timing of incurrence and the timing of actual cash payments are almost the same for these items. This includes salary, rental, utilities and many more. Many production houses have resorted to only maintaining a skeletal structure. This can be as small as 2 people managing the housekeeping of records and bank accounts for the company. The rest are reclassified as “project basis” as much as possible. This is the very reason why the Creative Industry has huge pool of freelancers.

In a nutshell, there are 4 critical management points that a creative entrepreneur needs to address. Number 1, the biggest mismatch between Profit and Loss and Cash Flows are actual revenues earned versus revenues collected; and actual costs incurred versus payments of those costs. Number 2, generally, the timing of incurrence and the timing of actual cash payments are almost the same for items such as monthly administrative costs consisting of salaries, rental, utilities as well as monthly interest payments and tax payments. Number 3, the critical item in Cash Flows that is not in the Profit and Loss is the financing element whereby cash inflow from borrowings as well as cash outflow for repayment of the borrowings is very crucial when managing cash allocations. Finally, Number 4, a business needs to have decent and appropriate financial indicators such as Gross Margin, Net Profit and Net Cash Inflows over Cash Outflows. Essentially, when you have considered the 4 critical management points, you can concentrate in refining your budget for the business.

What are the typical numbers for a budget? Let us start with Revenue. A Drama Series for a Free-to-Air (FTA) TV earns RM25,000 per 30 minute episode to RM40,000 per 60 minute episode. The series are normally done in 13 or 26 episodes package although some TV stations have commissioned long ones up to 60 to over 100 episodes. Telemovies for a FTA TV earns RM100,000 to RM300,000 per movie of 90 to 120 minutes. A cinematic movie has a different revenue model as cinemas share ticket collections with producers on a 50:50 basis. The revenue quantum for cinematic movies is really a wild card. It can be anything from less than a million Ringgit to RM40 million. Astro First pays RM300,000 for licensing a movie and then pays producers 40% of the subscription revenues subsequently.

A theatre production earns revenue primarily via sponsorships and secondarily via ticket sales. Tickets are priced between RM20 to RM100 per ticket with maximum capacity of the number of seats per session that depends on the size of the theatre. Kuala Lumpur Performing Arts Centre (KLPAC) for example can accommodate up to 500 seats in a session. There can be 2 sessions daily, which is Matinee and Night. The number of days a theatre show can continue depends on the stamina of the producers in paying rental of venue as well as actors’ and crew’s fees. The take up rate (seats sold) of a theatre show is normally between 50% to 80% if benchmarked against KLPAC’s shows.

For concerts and stand up comedies, revenues are primarily ticket sales driven and secondary revenue from sponsorships. Tickets are priced between RM50 to RM500 per ticket. Maximum capacity of the number of seats per session varies depending on the venue but a good benchmark would be Stadium Melawati in Shah Alam that has 8,000 seats. Similar to theatre shows, the number of days the show can extend will depend on the financial stamina for the live production and payments for logistics. The take up rate ranges between 80% to 100% which is much better than a theatre show. This has been benchmarked to LOL Events’ comedy shows as well as concerts such as Siti Nurhaliza, Search, Wings, Jamal Abdillah and M. Nasir.

Unfortunately revenue does not increase in tandem with the inflation in cost in the market. It only increases based on the negotiation skills of the producers. It is a balance between getting paid for commission work while losing the Intellectual Property (IP) rights or, otherwise, earn revenue sharing from the IP but own part of the IP. The financial implications of the two can be very different. Earning a revenue share may be as low as Nil if there are no revenues coming in. That is essentially the risk the TV stations are taking where some TV slots may not earn any advertising revenues. If the production houses are not keen to be exposed to the volatility of advertising revenues, then they should choose the commissioning path where the TV stations pay them commissioning fees regardless of whether the title makes money or not on TV.

Enough about Revenues. What about budgeting for production? Generally, approximately 80% of the contract value commissioned by TV stations should be assigned to the project. This means 20% is the so called ‘Gross Margin’ of the contract. Hopefully that 20% can cover the production houses’ overheads assuming enough projects in hand. How do you then allocate the production budget to its respective components? Based on numerous studies done by MyCreative Ventures when doing due diligence on its various TV production clients; pre-production gets 10%, casting gets 20%, the production team gets 20%, equipment rentals get 20%, post-production gets 20% and marketing gets the remaining 10%. However, many believe that marketing should get a higher percentage as high as 30% because without marketing, nothing can be sold.

Some numbers are worth being noted down for production budgeting purposes. For example, Stadium Melawati can cost up to RM80,000 per night. Istana Budaya charges RM15,000 per night. Various production studios in town have varying fee structure depending on equipment requirement. Costs generally have an inflation rate of 3% on year-on-year basis that is pretty much the reflection of the Consumer Price Index (CPI). In the recent years from 1999 to 2019, CPI has been around 2% to 3%. It is crucial that production houses observe economic indicators such as CPI as this provides the undercurrent consciousness of their monetary sense when managing production costs over time.

A drama production needs to incur scriptwriting fees, directing fees as well as producer’s fees. The scriptwriting fee is as estimated as follows: Drama Series (13 episodes x 30 min) at RM16,000, Drama Series (13 episodes x 60 min) at RM33,000, Documentary (8 episodes x 45 min) at RM21,000, Telemovie (90 minutes) at RM7,000; and Biography at RM33,000. The Director’s fee is as estimated as follows: Drama Series (13 episodes x 30 min) at RM26,000, Drama Series (13 episodes x 60 min) at RM39,000, Documentary (8 episodes x 45 min) at RM40,000, Telemovie (90 minutes) at RM10,000; and Biography at RM60,000. The Producer’s fee is as estimated as follows: Drama Series (13 episodes x 30 min) at RM7,000, Drama Series (13 episodes x 60 min) at RM13,000, Documentary (8 episodes x 45 min) at RM10,000, Telemovie (90 minutes) at RM5,000; and Biography at RM20,000.

Let us now move on to Overheads. Salaries of permanent staff at the market rate is growing at 5% per year and incurs Employees Provident Fund (EPF) rate of 12% and workers insurance (SOCSO) rate of 1%. Other staff related costs can be as high as 30% of the basic salary that generally covers over time claims, medical, training and other staff matters. Typical, the salary scale for a medium sized company pays Non-Executives at RM1,000 to RM2,000 per month, Executives at RM2,000 to 4,000 per month, Managers at RM4,000 to RM10,000 per month and puts aside a provision of RM300 per staff for medical claims a year. This does not include bonuses. Some companies are unionised to the extent that those unions demand a contractual bonus of 2 months pay. In that scenario, bonus is no longer bonus and behaves like a 13th and 14th month salary. With all these in mind, how many staff will you employ? In the end, when you do the budgeting for permanent staff, the inflationary growth of the cost is generally at 5% per year, higher than the CPI of 3%.

What are the other typical overheads? To name a few but not limited to, here are some benchmarks of costs: Accounting fee at RM500 monthly, Auditors fee at RM5,000 yearly, Bank Charges of 1% of the bank balance, Secretarial fees at RM500 monthly, Tax agent fees at RM5,000 yearly, Rentals at RM4 per square feet, Utilities at RM1,500 monthly, telecommunication at RM2,000 monthly, Petrol and Tol charges at RM1,000 monthly, Car maintenance at RM7,000 yearly and the list goes on and on with stuff such as insurance, legal fees, printing, stationeries, licenses, entertainment and many more growing at an inflation of 3% per year.

We touched the matter of borrowing earlier when managing cash flows. Essentially there are many formats of financing. A Term Loan incurs interest at approximately 6% to 7% per year with the requirement for monthly repayment of interest, monthly repayment of principal and once paid, no more drawdowns are allowed. A Revolving Credit incurs interest at approximately 6% to 7% per year as well with the requirement for monthly repayment of interest, principal repayment by cycles and once paid, can drawdown again in accordance with the cycle with an upper limit set for maximum amounts allowed for borrowings. The more complex method is an injection of funds into the company via an issuance of a hybrid debt-equity instrument called Preference Shares incurring dividend payable of 7% to 10% per year, payable annually until the Preference Shares get redeemed by the holder at the end of its tenure that are typically 5 years.

Term loans are suitable for capital expenditure (Capex) such as buying equipment for production purposes. Apart from the interest expense, the Capex will be charged to the Profit and Loss over its useful life as depreciation expense. Revolving Credits are suitable for on-going working capital requirement such as production costs where you can reuse the facility over an over again like how credit cards work. Preference Shares are normally issued by a company when it needs to raise funds for a longer gestation period to turnaround a business. For example, animation and game companies need longer development period. At the end of a term, the investor gets back the money plus annual dividends as rewards to the investment.

An entrepreneur ought to assess the business funding requirements and choose which type of financing suits its operations best. They can even have combinations of the different types of financing depending on the hybrid intended usage of cash. There are also initiatives by the Government to help the creative industry financially. Creative business owners must grab this opportunity and look out for Government grants available in the market such as FINAS’ 30% rebate on production costs and grants from entities such as TERAJU, Cradle Fund, Malaysian Digital Economy Corporation (MDeC) as well as the various ministries.

A crucial crossroad many production houses face would be to decide on whether to rent equipment and premises or to purchase. Purchasing it would mean incurring Capex. If we incur Capex, we will need to depreciate the costs over the useful lives of the assets bought. This depreciation gets charged to the Profit and Loss and hence, reduces the profits. An equipment is typically depreciated over 5 years but as technology gets updated in a more dynamic manner, we may have to accelerate depreciation to a shorter period of 3 years and below.

The decision to incur Capex rather than rental would mean: 1. Saved from incurring rental expense but ending up bearing the depreciation charge, 2. Saved from having to pay cash for rental but instead having to pay lump sum up front to buy the equipment; and 3. Increasing the risk of having negative cash balance early warranting a drawdown of loans that incurs interests or injecting your own money depriving passive income from unit trusts or money market deposits.

Indeed, managing a creative production house is not that easy. There are numerous more matters to deal with. What else? Well, consider looking at the entire business operations to identify other items for budgeting. For example, creative writing of programme description in multiple languages, pre-sales and post-sales support, services to programme buyers, managing programme and film rights, organising exhibition booths, preparing sales materials, film editing, music composing, soundtracks, sound effects, Dolby Digital Surround System fees, music IP rights fees, media advertising planning, on-ground road shows, radio interviews, TV appearances, photo shoots, social media shouts, distributors’ service (eg. airline, video-on-demand, Pay-TV, mobile, internet, home video, FTA TV and any other avenues that may require modifications to the content to suit their platforms), production consultancy for content that requires experts (eg. Historical or scientific researches), talent management (i.e. tours, endorsements, jobs scheduling, fee negotiations, etc), and many more.

To end this pain, in short, we can summarise all these as, “We need money to make money. In order to plan how to make money using money, we need a tool that can establish such order. That tool is Budget. Creative entrepreneurs must do their business budgeting. Period”.


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