This blog is about how to manage your cash, build reserves, and how to think about cash differently. But first, a little rant about my thoughts on cash vs debt:

Cash is hard and I’m sick of it. We live in such a debt-filled culture where way too many people are living off other people’s money, just trying to make that one payment. I’m personally so discouraged when I meet clients paying off tax debt that shouldn’t be unexpected and then can’t afford to get the help they need to dig out of that hole (in truth - they can’t afford to NOT get the help). I’m sad for people that have worked for years and years without paying themselves or just can’t seem to get to the next level. I’m generally annoyed at the lack of content around how to manage cash and build solid cash reserves in your business.

On a small personal financial tangent- I’ve been on a personal debt-free journey for a few years now. When my husband and I sold our Seattle house to move out to Olalla, WA I paid off my MBA student loan in one $65K payment (best moment ever), we paid off the one car payment we had left, and we paid off a HELOC. And I will NEVER go back. We have no car payments, no credit card payments, no student loans, no second mortgage. And while we’re still dealing with a small medical bill - I am ALL-IN on getting our one mortgage paid off in the next 10 years (or less!). It might come as a shocker to some, but I don’t even have a business credit card (I’ll wait while your jaw drops). I don’t have anything against them, but it hasn’t made sense for my business to date and I like spending cash not credit. (and no, the benefits of any points do not make sense for how few transactions I have every month–but if you feel you must tell me feel free to send me an email with your opinion).

While I’m not anti-debt, and I would consider an SBA loan to acquire a small business and help many clients get loans, I am debt-cautious and generally advise all strategies away from debt before going that route. And for one very particular reason:

DEBT must have an ROI (Return on Investment), and… yet most businesses use debt as a Band-Aid.

The same can be said for other types of fundraising but here’s the thing - the people you want to take money from are not going to give you “Band-Aid” money, they’re going to support you in your business goals and help you turn that money into more money.

With that context in mind, Let’s dig into cash and how to manage cash and build reserves the right way.

Cash is why you run your business.

When you pay yourself from your business or sell your business for millions of dollars - you get cash. Not physical bags of cash (though that would be fun), but you’re not borrowing money you just get to keep it. When you flip the script to think things through that way - you either need to build up cash (to then take out of the business) OR you need to create so much value that someone will pay you bags of cash when you’re ready to walk away. Typically people don't pay bags of money to businesses that are in tons of debt and can't generate cash. (though there are VC-backed businesses that are not cash flow positive that do get big payouts - those are not the norm!)

Cash has to be the focus of your business. Unfortunately, making that the case isn’t an intuitive process.

To help me frame up my method, I developed the Cash Management Triangle:

The Cash Management Triangle has 3 points:

Planning - cash flow, budgeting, forecasting - the day-to-day function of your cash management
Working Capital - what cash do you have and what do you need to bridge the gap between when you get paid and when you have to pay expenses
Reserves - what are you planning for in the future?

Planning:

Have you ever taken a road trip without a plan? Sounds fun right? And for some people it is, but what if you didn’t pack the right clothes or food, or didn’t look ahead to see when you needed to fill-up your next tank of gas and you got stuck on the side of the road? Sounds less fun to me. Some people might be able to get further than others depending on the challenges they face, but in the end, lack of planning can mean your demise (or just lack of fun).

Planning for cash is no different - there are some businesses that make enough money that they can afford to plan less, or not at all and they’ll get by for a while. While some can get by that way for a while, often it is a false sense of security and eventually, the lack of planning will catch up with them. What I’ve seen most often in these cases are businesses that are doing well with margin and sales growth, but the owners then decide since they've done SO well, they can double or triple their businesses and then are hit with the reality they never laid the right financial management foundation and things start to fall apart.

Planning for cash has 2 main components:

A budget or forecast
Cash Flow plan

Budget / Forecast:

For the sake of this post, budgets and forecasts have the same purpose - they’re your plan for where the revenue will come from and where you’ll spend the money to generate more revenue. To keep things simple, I’m going to refer to both budgets & forecasts as budgets.

When you build a budget, you’re creating a plan for your business. At a minimum - plan out the next 12 months. You will need to adjust the budget based on each month’s new information - maybe one month you need to spend more than you planned and one you need to cut back because revenue dipped. Just remember- this is your initial plan (or annual plan) and it does adjust.

Cash Flow plan:

A cash flow plan (also called a cash flow forecast): is specifically looking at the timing of when cash comes in and goes out.

This can be pretty simple. Some businesses can get to reviewing this monthly, some need weekly management or even daily. Ideally, once you have working capital in place, monthly is a sufficient way to manage with some larger quarterly or annual adjustments.

Working Capital - what cash do you have and what do you need to bridge the gap between when you get paid and when you have to pay expenses.

There are two parts of working capital:

Current state of working capital (Current Assets - Current Liabilities)
Forecasted Working Capital - what do you need as your business grows?

Check out my freebie working capital calculator here

Your current working capital can be found with a simple calculation from the balance sheet.

Working Capital = Current Assets – Current Liabilities

Let’s say that you have $25,000 in cash and in the next 12 months you owe $10,000 in credit cards

Then your current working capital is:

$25,000 - $10,000 = $15,000

This is telling you that you have $15,000 that isn’t reserved for a particular payment and can be used to bridge the gap between when cash comes in and cash goes out.

Let’s say that you have $15,000 in working capital, but you’re still draining your bank account at least once if not more times per month - maybe you need MORE working capital in your account.

Forecasted working capital is all about what you WILL need as you grow.

The inputs are a little different:

Days of sales outstanding (DSO) or AR terms
Days of Inventory outstanding (DIO) or the opposite of inventory turns
Days of Payable Outstanding (DPO) or AP Terms

From there you can calculate what you NEED to have in working capital. I like to use this calculation to look 3-6 months or even 12 months in the future (if you’re in high growth mode) to see if you need to increase or decrease your working capital to help smooth cash flow.

You can find how to do this on your own via this free download.

Here’s a screenshot of what yours may look like, if you don’t carry inventory:

Reserves - what are you planning for in the future?

After countless cash flow forecast in the past 4 years, I’ve distilled cash reserves into 3 main buckets:

Oh S*IT $$ (aka the emergency fund)
Taxes
Investments

Oh S*IT $$ or the Emergency fund needs to hold cash for things like:

Your revenue suddenly drops to zero, but you still have commitments (usually this is unlikely, but hey that’s why you have it!)
Your revenue dips a little, but you haven’t adjusted your expenses down
You received some kind of completely unexpected expense (i.e. equipment breaks, you get sued, you get sick)

The amount needed in this bucket varies by business type and how the cash flows through the business. On a general level here’s what I recommend:

At least 3 months of expenses (more if you have a long sales cycle or seasonality)
A buffer on top of those 3 months of expenses - call it $25-30K, it could be higher or lower depending on your gross revenue bracket
Anything else that could go wrong specific to your business:

If you have trucks or equipment << save up the downpayment for a new truck or piece of equipment
If you work off your computer << start saving for a new laptop every few years just in case

There are several businesses that should have closer to 6 months of expenses, or some that could go with less (not recommended). It often depends on the team size (1099 or W2) and how quickly you can make new sales (sales cycle).

Taxes!

Everyone’s least favorite subject they can’t escape. Taxes shouldn’t be complicated to save for, but they are often an afterthought. A quick way you can correct your business is to ALWAYS be setting aside money for taxes.

State / Local Taxes:

State & local taxes: I find to be the most complicated because there’s so much variability in how those are managed. For your sake, simply look up where you live and understand what % you need to pay for those taxes. Save that in a tax account each month and then when you file your taxes use that account to pay for it.

Sales tax: Okay I lied; Sales tax when you’re selling across state lines is the WORST - so hire an expert to help you manage this. But it is manageable. The things to keep in mind - the thresholds for paying sales taxes in various states (sometimes cities or counties) are all different. Georgia for example is by number of transactions whereas as California is triggered when you have an employee in that state or sales volume whichever is first. So on this one, get a solid team to take care of this for you.

Federal Taxes: I find this one the easiest to manage. I would say 70% of my clients are LLC’s or S-corps which are both pass-through entities.

LLC’s you are taxed with your federal taxes (sometimes needing to do quarterly payments) but you’re basically paying a % of your net income by your tax bracket. All you need to do is look at what bracket you were in (or will be in if you anticipate a huge boost in business) and each month save that % of your net income in a separate account. Another good way to do this is each time you do an owner’s draw, save that same % in a personal money market and don’t touch it until tax time (personal money markets usually get higher interest rates, here’s my favorite Betterment offers > use my link and get 0.50% APR added for 3 months!)

S-corps are taxed similarly, but the owners are also considered W2 employees. For businesses set up this way which are regularly processing payroll, those payroll taxes are coming out each month and go towards your annual personal return. W2 income goes on the P&L and would come out of your Net Income. You still need to save a % of your net income each month to cover any gaps, but that will be fewer dollars overall.

C-corps a little different since the business is taxed and that varies by state. All my C-corp clients have CPA’s that manage this for them and the owners are on W2 with the possibility of dividends each year (which would be similar to owner’s draws, but are less flexible because they are usually more than one owner).

The main takeaway for taxes are:

Don’t borrow from the government - so put that money aside until you must pay it
Talk to your CPA or CFO about the rates specific to your business
Don’t make it complicated

CASH is KING!

What do you currently do to manage cash?

If you take nothing from this blog, notice that I did NOT once say to look at your bank account each day. You could do that - not terrible, but there is SO MUCH MORE to cash management than checking a bank account. And a bank account doesn’t tell you where you will be. It only tells you what you have today.

Here are a few next steps for you:

Think about what works and doesn't work in how you manage cash today
Ask yourself:

Am I prepared for a cash emergency?
Do I have the resources to cover myself if my revenue dips to zero tomorrow? For how long?
Can I keep paying my people if I spend $X today?
What are my long-term goals? Am I building reserves to support them?
Have I been saving what I need for taxes?
What will surprise me most if something changes in my business tomorrow?

Just one last note on debt, when you have this cash management set-up, debt (or other funding) becomes the only thing to accelerate business growth beyond what you can do with slowly building cash reserves. It allows you to speed up your business growth, without it being a Band-Aid. And you become free to strategically grow your business, not simply reacting to cash mishaps.

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The Cash Management Triangle: Where Cash is Grown - Not Lost!