I have been preaching about the need to build strong cash reserves in small businesses ever since I first started teaching entrepreneurship.
While some people have taken my words to heart, many assumed that the good times will always roll. This latter group of entrepreneurs acted as if the truism “cash is king” was a mantra for spending more, rather than saving more.
Most of the ventures that come out of the other end of this recession intact and ready to roll, will be those that went into the recession with healthy cash balances in their bank accounts.
Times are getting tight for many entrepreneurs, as seen in this piece by Simon Covel in the Wall Street Journal:
During past downturns, business owners might have turned to a home-equity line of credit, a personal loan or credit cards to shore up finances. But this time, real-estate values have plummeted, leaving many with less equity to tap, and bank credit is virtually nonexistent.
It’s not uncommon for owners to give up salaries from time to time to give their companies a temporary lifeline, but business advisers and owners say the prevalence of salary cuts now is unusual where to buy topamax even for a recession.
So what should you do if your cash is tight and you are hanging on by a thread? Realize that your options are few and that it is time to tighten your belt both for your business expenses and for your personal finances. Employment continues to soften, so the prospects of a paycheck from someone else’s business are not that great. And starting another business to replace the one that is struggling will likely require even more cash that it will take to keep this one afloat.
And once you survive? Remember the lesson you have learned. Cash is indeed king. Don’t ever let yourself get complacent about your business’s future success again.
Once your business begins to recover, build up your cash as soon as you can. Thirty days is the minimum you should always carry — it will get you through the short term bumps in the road. Then work toward ninety days of cash reserves, or more if you can.
If this recession teaches you anything it is that rainy days are not your biggest worry — “rainy years” are what you need to plan for.
Dr. Cornwall,
I am a civil engineering consultant operating under a 1 employee LLC (taxed as an S-Corp) in Florida. My industry has taken a huge hit in recent months and it has exposed the cash-flow dependence of many firms (large and small). When asked “Why didn’t you build up a cash reserve in case business got slow?”, their response is usually “We would have to pay a 38% tax on cash that we carry from one fiscal year to the next.” If that is the case, how do companies build up cash positions at all?
I am not sure why they would say that carrying cash leads to taxes every year. Income taxes are paid in the year you earn them, not on a recurring basis. You don’t get taxed on your cash balances — at least not yet…..
What I urge entrepreneurs to do is to following my 1/3, 1/3, 1/3 rule. Set aside 1/3 of cash flow to pay for taxes on pass through income, 1/3 of cash flow to invest back into the business to build reserves, and 1/3 used to pay down debt. If you have no debt, put 2/3 in reserves until that are built up to a safe level.