Step 1: Build Your Cash Balance to One Month of Operating Expenses

In my last post, I shared an achievable, 10-step plan for making your business strong financially.

I provided a roadmap you can use as you build your company over time.

Let's look at the first step in that process.

Step 1: Build your cash balance to one month of operating expenses.

If you have less than one month of operating expenses in the bank you are likely experiencing unnecessary stress, angering your vendors, irritating your employees, ignoring the financial reality of your business, and generally making your life harder than it needs to be.

Maintaining a very small bank balance in business turns otherwise simple processes into complicated and time consuming hassles.

You end up paying vendors late. The slightest slowdown in collecting accounts receivable from your customers causes panic. Employees wonder what's going on. Your credibility takes a hit from all sides.

All because you are running your "gas tank" so close to empty.

Here's an Example

Let's say your monthly operating expenses are in the $500,000 range and your bank balance has been hovering around $300,000. That's probably not much more than a couple weeks of payroll and recurring expenses. That's too close for comfort.

So your goal in this example is to add $200,000 to your cash/bank balance. You need to ask yourself two thought-provoking questions (in this order):

• How fast can I come up with an extra $200,000?

• Where is the $200,000 going to come from?

I love these two questions because they generate some interesting reactions and thoughts.

The first question forces you to think in terms of a specific dollar amount you need to "find". And it forces you to consider just how long it might take you to achieve your goal. One month? Two months? Twelve months?

Sometimes the goal looks easy. Other times it creates dread and fear because you don't see a path to ever achieving the goal.

The second question reveals whether you really understand your existing cash flow or not. Do you know the three largest drivers of your cash both historically and over the next six months?

To answer the question of where the cash going to come from, you have to think through each of the key drivers of your cash flow.

And you have to decide what driver needs to change, and how you are going to make that change happen, in order to free up the extra $200,000 of cash.

Your Company

To implement step 1 in your company, you need to:

1. Determine whether you already have one month of operating expenses in the bank
2. If you are short of the one month target, then put a dollar amount on how much cash you need to "find"
3. Put some thought into where the cash is going to come from

The one month target is based on operating expenses. I exclude most cost of goods sold (unless you have employee expenses in cost of goods sold).

If you have a bank line of credit (LOC), and use your cash to pay down the LOC daily, you need to include an analysis of how you are using the LOC (and your availability under the LOC) in Step 1.

 

More on the 10 step process for winning financially in business in upcoming posts.

 

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