Is All Money Created Equal?

Is all money created equal?  If you think money is money – think again.  Whether for personal reasons or for your business, do your best to establish some level of a cash reserve.  Call it a “rainy day” fund, a reserve account, etc.  Something is better than nothing – and more is better than less.

Establishing A Cash Reserve – Why?

Into every life (or in every business), a little rain must fall.  You will appreciate establishing a reserve account when you have to wait out that next little storm.

In business, there are bumps in the road.  And, there can be derailments – derailments significant enough that you either have to pull off the road or you become stalled out and will need a tow.

Whatever the case, having a cash reserve can help you navigate these inconveniences.  Inadequate cash reserves may result in you having to make harder decisions that will put you off track from your current trajectory.

Establishing A Cash Reserve – How?

If the economy crashed, how many months of operating expenses would you want to have in reserve?  Three months?  Six months?

Here’s a simple exercise:

• Step 1.  How much money does it take to run your business every month (e.g., rent, salaries, owner’s draw, utilities, etc.)?  These are your fixed, recurring costs, or your overhead.  If you had no sales revenue, what would you have to pay out to keep your team in place and keep the lights on?  This is your monthly cost to operate your business.  In a well-constructed Income Statement (e.g., P & L), it is everything below “Gross Margin.”  Sales less Cost of Sales equals Gross Margin.  Then, comes everything else.  You want “everything else.”  If you are a small business, make sure you add “Owner’s Draw” to this.  Owner’s Draw is the amount of money you take out of the business to pay your personal bills.  This is a Balance Sheet item – so it needs to be added to the expenditures in the P & L.
• Step 2.  Now, in your opinion, how many months of the result in Step 1 do you feel you need to operate successfully?  Three months?  Six months?  Twelve months?  The question is this.  How much time would you need to be able to turn-around your business if …?  There was a significant change in the economy.  Or, the loss of a key executive or salesperson.  Or, the loss of a couple major customers that comprised 80% of your business?  Each situation is different.
• Step 3.  Multiply Step 1 by Step 2.  This is your Cash Reserve.  NOTE:  This is not technically-speaking, working capital.  Working capital is Current Assets minus Current Liabilities.  God-willing, set about systematically establishing this fund over a reasonable period of time.

Drive Safely

Once you establish a reserve account, do your best to be disciplined about maintaining it.  In addition, if your business is blessed to grow, be advised to go through the above exercise to see if your cash reserve needs to be augmented.

Avoid the temptation to use your reserve account for that down payment on the brand new home, commercial building, etc.  If you spend your reserve account on a “long-term” investment (e.g., like a home or building) – you will have a hard time getting that money back out if you need it for that short-term cash crunch you or your business might be experiencing.  If your business slows – and you reach for your rainy day money (and it’s in your building), you have lost access to an important resource.

You may have to sell your office building to keep your business going.

If you do encounter a rainy day or a bump in the road and you have to tap into your reserve account, do your best to re-establish it as soon as you can.

The Final Question

So, here’s the final question: Have you established a cash reserve fund for yourself and your business?

Contact us.  We’d love to help.