Cash cushion: how much to keep
You may have read recently that Apple Inc. now has more cash on hand than the U.S. government. I’m not sure if that says more about Apple or the U.S. government but, either way, it got me thinking about how much cash a business should keep at the ready.
Here are my rules of thumb:
Three months’ expenses: rainy day fund
When the second plane hit the twin towers on Sept. 11, 2001, I was in a prospect’s boardroom pitching him on becoming a customer of our research company.
As the gravity of the situation unfolded, I excused myself and walked back to my office where my employees were waiting to see if we were going to evacuate the building for fear of a similar attack in Toronto.
A few days after the initial shock and sadness of that day, we started to realize what a profound impact 9/11 would have on our business. At the time, 80 per cent of our revenue came from customers in the United States – many of whom, including American Express, British Airways and Citibank, were headquartered in New York.
The only communication we had with our New York-based customers in September of that year were calls and e-mails of condolences.
We started to gently initiate commercial conversations with U.S.-based customers in October but, for many, the wounds were still too raw to discuss business.
By November, the entire economy was stuck in neutral and, while some of our customers were getting back to business, many had slashed their budgets and were cancelling projects to which they had committed back in August.
Our company went from generating excess cash to sucking it up quickly. Our incoming cash went to almost zero while our expenses continued to chug along. At that point, I was grateful to have built up a three-month cushion of rainy-day money.
If you’re thinking of building an emergency fund for your company, consider keeping the money in cash or reasonably liquid investments. Putting your excess funds into the stock market for a couple of extra points of return may seem tempting until you that the world events that cause you to need the emergency fund are often the same disasters that trigger a selloff in the stock market.
After 9/11, the New York Stock Exchange remained closed until Sept. 17. On the first day of trading after the attacks, the Dow Jones dropped 7 per cent, at the time, the largest single-day drop in history, and, by the end of the week, it was down by 14 per cent.
The lesson: Keep your emergency fund out of the market.
Four to six months of expenses: Sleep like a baby
Running a business can be one of the most intense, stressful ways to make a living. To take the edge off, build up an extra cash cushion to act largely as a security blanket.
With four to six months of cash on hand, you know you can absorb the loss of a key customer or the failure of a new location or product and still pick yourself up and move on.
I think the greatest benefit to a healthy cash cushion is that it gives you the confidence to stick to your business model. If you’re running short of cash, it’s too tempting to give in when a customer wants a special customization or one-on-one consulting advice or some other distraction that undermines your business model.
Six-plus months of expenses: A gambling fund
In Exploiting Chaos, Jeremy Gutsche, the Toronto-based founder of Trend Hunter, describes the mechanism that the BBC uses to bankroll oddball projects.
The BBC sets aside a small amount of money to “gamble” on wacky ideas that don’t fit its typical format. That’s how The Office, one of the most successful shows in the history of the BBC, was funded.
If you have six-plus months of expenses, you know you can deal with an immediate crisis, absorb the loss of a key customer or a big mistake and also gamble a few bucks to test some wild ideas – one of which actually might work.
John Warrillow is a writer, speaker and angel investor in a number of start-up companies. You can download a free chapter of his new book, Built to Sell: Creating a Business That Can Thrive Without You.
Join The Globe’s Small Business LinkedIn group to network with other entrepreneurs and to discuss topical issues: http://linkd.in/jWWdzT
Here are my rules of thumb:
Three months’ expenses: rainy day fund
When the second plane hit the twin towers on Sept. 11, 2001, I was in a prospect’s boardroom pitching him on becoming a customer of our research company.
As the gravity of the situation unfolded, I excused myself and walked back to my office where my employees were waiting to see if we were going to evacuate the building for fear of a similar attack in Toronto.
A few days after the initial shock and sadness of that day, we started to realize what a profound impact 9/11 would have on our business. At the time, 80 per cent of our revenue came from customers in the United States – many of whom, including American Express, British Airways and Citibank, were headquartered in New York.
The only communication we had with our New York-based customers in September of that year were calls and e-mails of condolences.
We started to gently initiate commercial conversations with U.S.-based customers in October but, for many, the wounds were still too raw to discuss business.
By November, the entire economy was stuck in neutral and, while some of our customers were getting back to business, many had slashed their budgets and were cancelling projects to which they had committed back in August.
Our company went from generating excess cash to sucking it up quickly. Our incoming cash went to almost zero while our expenses continued to chug along. At that point, I was grateful to have built up a three-month cushion of rainy-day money.
If you’re thinking of building an emergency fund for your company, consider keeping the money in cash or reasonably liquid investments. Putting your excess funds into the stock market for a couple of extra points of return may seem tempting until you that the world events that cause you to need the emergency fund are often the same disasters that trigger a selloff in the stock market.
After 9/11, the New York Stock Exchange remained closed until Sept. 17. On the first day of trading after the attacks, the Dow Jones dropped 7 per cent, at the time, the largest single-day drop in history, and, by the end of the week, it was down by 14 per cent.
The lesson: Keep your emergency fund out of the market.
Four to six months of expenses: Sleep like a baby
Running a business can be one of the most intense, stressful ways to make a living. To take the edge off, build up an extra cash cushion to act largely as a security blanket.
With four to six months of cash on hand, you know you can absorb the loss of a key customer or the failure of a new location or product and still pick yourself up and move on.
I think the greatest benefit to a healthy cash cushion is that it gives you the confidence to stick to your business model. If you’re running short of cash, it’s too tempting to give in when a customer wants a special customization or one-on-one consulting advice or some other distraction that undermines your business model.
Six-plus months of expenses: A gambling fund
In Exploiting Chaos, Jeremy Gutsche, the Toronto-based founder of Trend Hunter, describes the mechanism that the BBC uses to bankroll oddball projects.
The BBC sets aside a small amount of money to “gamble” on wacky ideas that don’t fit its typical format. That’s how The Office, one of the most successful shows in the history of the BBC, was funded.
If you have six-plus months of expenses, you know you can deal with an immediate crisis, absorb the loss of a key customer or a big mistake and also gamble a few bucks to test some wild ideas – one of which actually might work.
John Warrillow is a writer, speaker and angel investor in a number of start-up companies. You can download a free chapter of his new book, Built to Sell: Creating a Business That Can Thrive Without You.
Join The Globe’s Small Business LinkedIn group to network with other entrepreneurs and to discuss topical issues: http://linkd.in/jWWdzT
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