Your cash reserve - a key to business survival during hard times.

Sharing this insightful exit strategy series by Justin Goodbread providing Canadian context.

No matter how strong your business plan is or how well you grow your team, your business needs enough in its cash reserve to survive financial storms. In order to secure outside funding or know how much money you need to save personally, you must know how to calculate how much of a cash reserve your business needs to have on hand to withstand hard times.

Without substantial resources to sustain profitability, businesses will most likely fail. But lack of cash can’t be the only reason companies fail. We’ve seen many clients begin a business with more cash capital than others will make in a lifetime. We’ve also seen those same companies go bankrupt and close their doors.

What, then, causes businesses to fail? Chicago business owner Jay Goltz offers plausible answers to that question. In 2011, the nytimes.com published his article, The Top 10 Reasons Small Businesses Fail . Here's a breakdown of the reasons:

10 Reasons Businesses Fail

1. Product cost comes too close to its sale’s price.
2. Owners’ stubbornness, perfectionism, or greed get in the way.
3. Success happens too quickly for companies to keep up with demand.
4. Owners without financial knowledge fail to oversee their accounts and without financial know-how try to handle their own accounts.
5. Business does not have enough cash capital.
6. The company fails to rise above mediocre customer service or product offering.
7. Owners pay too much or too little for operational expenses like rent, equipment, and labor.
8. Management fights amongst themselves or with employees.
9. Owners don’t develop an exit plan.
10. A company’s product or service becomes outdated or unnecessary in the current market.

While all ten reasons cause businesses to fail, we believe number 5 is one of the main reason businesses go under. From our own observations, we find that many businesses simply don’t have enough cash reserves to weather storms that come.

?In the unpredictable world of business, maintaining a healthy cash reserve is not just a prudent strategy—it's a lifeline. As entrepreneurs, we face constant challenges and uncertainties, from economic downturns to unforeseen expenses. In this insightful exit strategy series by Justin Goodbread, tailored for the Canadian context, we delve into the critical importance of cash reserves in weathering the storms of entrepreneurship.

How to Calculate Your Business’s Cash Reserve Amount

That leads us to the next issue: determining how much cash reserve will be enough to sustain us through the tough times.

In most circumstances, businesses can predict the capital needed with a pro forma financial statement or cash flow forecast. The methodology within the hypothetical calculation applies to almost all types of businesses, so let’s go through this process together.

• Decide how long it will take your business to move from start-up to profitability. – Let’s say it will take two years before you become profitable.
• Calculate anticipated recurring monthly, quarterly, and yearly expenses you will incur during that time frame. – Let’s assume you’ll spend $800,000 over that two-year period.
• Conservatively estimate the gross income you will receive during that time frame. – Hypothetically, let's say you’ll earn $600,000 or 10% profit on $6,000,000 million in revenue.
• Subtract the projected income from the predicted expenses to calculate the shortfall. – $800,000 minus $600,000 equals $200,000.

Our projected $200,000 shortfall is the bare-bones amount of cash reserve your business will need for sustainability, for survival amidst the forthcoming storms.

But don’t stop there. Notice that we said “bare-bones amount.” We'd suggest adding another 20% buffer into my projected business cash needs. Therefore, if your calculations tell you you'll need a $200,000 cash reserve, begin with $250,000 to safeguard yourself against unforeseen circumstances or shortfalls in your revenue target.

How to Fund The Cash Reserve

By this point, you may be saying, “How in the world can I get this much money to start my business?” If you’re already in business, you may be wondering, “Do you honestly think I’m going to be able to save that ungodly amount of money when I’m barely getting by day-to-day right now?”

This can work. You can find funding for cash capital and cash reserve, but the funding available will most likely depend on how realistic your forecast is. With a strong, projected financial statement, you can:

• Apply for a conventional bank loan or line of credit.
• Get a higher-risk loan from BDC Bank.
• Reach out to an outside investor or family member
• Sell a minority position in your business as part of your exit strategy
• Sell or leverage assets you already own.

Stash the Cash

Once you have the cash reserve, preserve it. Cash is king in business sustainability. Squirrel it away. Put it in a savings account or a GIC you can’t get too easily. Protect it. Invest it. Pay yourself the accumulated interest.

Next pay yourself 10%, 15%, or 20% of your business’s gross income as a dividend each month to create a personal emergency fund. You've worked too hard and are exposed to many countless risks not to protect your investment.

Then, do whatever it takes to get more customers. When times are good, pour extra income back into marketing and advertising so more people know you’re around. Furthermore, take care of the customers who come through your door so that when customers have to be stingier with their money during the tough times, they’ll come back to you instead of your competitors.

Cash Out

So if the whole point of this blog series is to build a business to sell it, we have to focus on business sustainability. Economic storms will come. Maybe they come during natural disasters like floods, fires, or tornadoes. Perhaps they come when loved ones fall ill or family members begin feuding. No matter how the storms come, we know they’re coming.

Therefore, stabilize your business with scalable processes and strong operational management. Then, recruit the best team members you can afford to build and strengthen the foundation of your business based on your value proposition. But if you stop there, you'll have no safeguard against the storms. Even if you build your business on the proverbial rock, without additional cash reserves, cushions, or protections around the structure, you’ll likely still be swept away by the waves or receive no value in a forced liquidation with little to no return for your hard work and investment.

Building a business isn't just about creating value—it's about safeguarding that value for the long haul. Cash reserves can be a crucial buffer against the inevitable storms that may come our way. By calculating and diligently funding our cash reserves, we can fortify our businesses against uncertainty and lay the groundwork for sustainability and success.

Simon Fallows CEPA?, owner of Freedom for Founders, a Canadian exit strategist, entrepreneur, and investor who has experience starting, selling, and buying businesses. A thought leader working with a broad range of product, service, and retail business owners helping them maximize their company's value, personal wealth, and wellbeing

References: Justin A. Goodbread, CFP?, CEPA?, CVGA?, owner of US-based Heritage Investors, LLC and FinanciallySimple.com , is a nationally recognized financial planner, wealth manager, financial educator, author, speaker, and entrepreneur.?