Cash flow is the lifeblood of a business. It needs to be steady and constant and any restriction of it will cause panic and pain. When most businesses start out there are many variables that contribute to inconsistent cash flow. New ventures struggle with deciding what features to add to a product, who the target audience is, and what marketing strategy is an effective way to reach that market. The struggle to answer all of these questions creates a feast-or-famine mentality where you are constantly hunting for the next meal that will feed you for a few days. While revenue is fluctuating up and down long-term planning doesn’t normally happen. especially if you are relying on the business income to maintain a household. When I was trying to build a freelance business and later trying to build a plugin business all the money left after taxes and expenses came home in the form of salary. I would leave my business account near empty waiting for the next invoice payment or plugin sale. Because of this method of operating I believe I missed out on opportunities that I would have been able to take advantage of if I had a cash reserve.
The ability to go into debt is not a business reserve
You may be thinking “Well, I’ve got a credit card or a line of credit available when I need it.” Using credit to make a strategic move is a bad idea since the move may fail and go away, but you’re still left with the debt. Also, using credit to stay afloat while in a low swing of revenue just amplifies the problem and brings on more stress. I do not suggest using credit as a reserve. Cash is king!
Business reserve for the solopreneuer
Once your business is profitable and earning ongoing steady income it is a good time to think about creating a business reserve. A business reserve is essentially a savings account for your company. Just like you should have your business accounts totally separate from your personal accounts. You already do this right? right? 🙂 You should keep your business reserve in a separate account to keep it separate from your normal operating, payroll and tax accounts.
Defining a cash reserve
Talking numbers helps clarify points so for this conversation I’m going to say that a cash reserve for a soloprenuer is 6 months to a year of business expenses. Whatever it takes to keep your online business or SaaS running for a month, multiply that by 6 or 12 and get the number. How many months you choose to use as the multiplier depends on your risk tolerance, the how disruptable your market is, and how many people are depending on your business. As an example say it takes $2,000 per month to cover all of your expenses: web hosting, marketing costs, support of current products and transaction fees. Note that this doesn’t include any salary, but only includes ‘keeping the doors open’ to make new sales. I keep a personal reserve at home that covers any disruption of my salary. This money is after-tax money and covers 3-6 months of household expenses. I chose to handle my personal income separate to not put too much burden on the business. In this example a 6 month cash reserve would be $12,000 and a 1 year cash reserve would be $24,000. This money would be put into another account and left to sit until needed. I’ll define where it could be used in a moment. Contractors vs employees In the example above I removed my personal salary from the equation because as the solopreneuer I am much more interested in the business succeeding and provide long term income than making a paycheck that suffocates the business in its infancy. There is a difference if you have employees or contractors who rely on the business for their livelihood. There is an implied weight of responsibility that comes along with asking someone to bet their time and talents on your idea. You’ve got to take that seriously and strive to never, ever miss payroll. The nature of the contractor relationship is more transient than an employee, but you should still plan on always paying on time or early no matter what is happening in the business.I’ve been paid late as a contractor and have paid contractors late and I will never be in either position again. It’s not fun for anyone involved. If you are recruiting someone for a long term contract keep the balance of the contract in your reserve and don’t rely on future sales to pay them. Having employees is a different situation. I once asked a business owner I respected about when it was time to hire an employee. His advice was that you shouldn’t hire an employee until you had one year of their salary in the bank. If you would pay them $50,000 per year, then you should have $50,000 in the bank. That way no matter what happened with the business you could do right by that person if there was a dip in business, or if business dropped off and you had to let them go. At the time that was an enormous amount of money to me and I made the decision to not hire an employee and that was the right decision for me.
Money to make long term decisions
So what should you use business reserves for? Other than keeping the business going through times of low revenue there are two things you can use a business reserve for. Develop new products Having a cash reserve and a new idea are like peanut butter and jelly, they go together well! If there’s a new product you want to develop there is some risk involved because no matter how much you validate you don’t know if the product will be a success. Instead of using debt or choking cash flow to fund new products you can use part of your reserve to fund the new product. If it fails you learn from the experience and rebuild your reserve. If it succeeds then you made a great move without jeopardizing your cash flow. Acquire products/businesses Sometimes an opportunity will come along to purchase a product or business. You can bet that if you don’t plan for this scenario the opportunity won’t coincide with a big influx of cash from product sales! Purchasing products is similar to developing products but comes with less risk. The right products have sales history and a customer base. This can be the right move for you, but you have to be ready for it. A cash reserve is If you don’t have a cash reserve, I highly suggest you make a plan to create one. If you do, then well done! Does your business have a cash reserve? How have you used it in the past?