Everyone needs a safety net. But just how much cash should you have in reserves to support your business should sales take a dive, a top sales producer quits, a big client starts getting delinquent with their payments, or you’re unexpectedly struck by an illness?
A good rule of thumb is to have 3-6 months’ worth of savings on hand to cover your operating expenses. The same goes for a freelancer or consultant, although the savings would be used to cover any personal expenses. However, for most people, that’s a big chunk of change and can take some time to shore up. So what are your options? Let’s take a look at how you can arrive at a contingency fund that makes sense for your business and the peaks and troughs it may encounter:
Run a Simple Cost Analysis
First, you need to understand what your working capital you have available (essentially the liquidity in your business). Your balance sheet will tell you this number – just deduct your liabilities (monthly loan payments, accounts payable, etc.) from your current assets (money in the bank, payments owed to the business, and inventory value).
Next, calculate your operating expenses for the past 12 months (look to your income statement for these numbers). These include utilities, lease payments, and other regular monthly expenses. Divide this number by 365 to get your daily operating expense (what it costs to run your business each day).
Then divide these two numbers – working capital by daily operating expense – and you’ll arrive at the number of days you can fund operations based on the cash you have on hand.
From here you should be able to calculate your contingency fund budget. Don’t go wild but do make sure you have enough cash set aside to keep your business running for a few months, should problems arise. It’s also a good idea to factor in several scenarios, such as a one-month dip in business compared to a three-month dip.
And remember, your overhead costs (such as bank loans and lease payments) aren’t going to change during this time, so you’ll need a plan to cover those too. However, you will save some money in terms of production or sales costs during a quiet period.
Can’t Find Money for Your Safety Net?
Now, if your business is new, your margins are tight, or you operate literally on a month-to-month basis (as many freelancers do), then finding the money for your safety net is going to be a problem.
Some options that may be available include your current assets (money in the bank, outstanding payments owed to your business, a business credit card, etc.) as well as your personal savings. You could also consider a line of credit (a useful financial resource for startups and those in need of a safety net).
Another option comes from Fundbox. This popular service can help you cover the costs of unpaid invoices (a common cause of cash flow problems) by advancing payments for those outstanding invoices, without the need to dip into savings.
Treat It As A Balancing Act
As your start-up grows consider setting aside 5-10% of your revenues in a reserve account, and keep reassessing this number as your business grows. It’s a balancing act between having the cash reserve to keep the lights on during tough times, but not one that’s so big that it stymies your growth.
