What would happen to your business if, for example, out of the blue, your entire marketplace shut down completely, say because of a global pandemic? Would you have enough cash available to you to meet your expenses for an uncertain amount of time?
Pandemic aside, sometimes, things happen that put a halt on immediate cashflow. We’ve worked with clients who have experienced significant cashflow impact due to illness, injury, disruptions to stock availability or their supply chain, just to name a few examples. Ultimately, the businesses that come out on the other side are those which have had a plan for the unplanned- namely a robust buffer.
Contingency Plan. Buffer. Reserve. Plan B. Rainy day fund. Safety net. Slush fund. Cushion. Different names, same concept. We use the term ‘cash buffer’ to describe the amount of money sitting in a (specified) account to meet the operational costs of running a business for an extended period of time.
While there are many different names for a cash buffer (one of our clients calls hers the ‘poo/fan phenomena fund’) having cash set aside to cover either a decrease in cashflow or unexpected expenses is a critical strategy for a sustainable, successful business.
A question we’re asked when discussing this concept with our clients is how much cold hard cash should be set aside for a buffer? There’s no universal answer for every business. The amount must be determined specifically against your needs and your business’ financials. The bottom line is to have enough of a buffer to cover your expenses- business and personal- for at least three months, but ideally six to nine months. The way to determine this is to deep dive into the past twelve months’ worth of data, which, if you’re having a regular catch up with your numbers, won’t be as intimidating nor as intensive as it could be perceived.
As you go through your financial reports, determine what it costs you to run your business for a year- for example, to pay your employees, your rent, your stock and equipment. Examine your expenses with close analysis. Did you have some months where your earnings were significantly higher than your expenses? Conversely, did you spend a lot of money setting up a new staff member? Did you deck out your office in new hardware that won’t need to be replaced for several years?
Now, complete your forecasting and your projected income for the next year. Of course, be guided by the previous year, but considered. Have you committed to more networking this year to enhance your visibility in an attempt to increase your client list? Do you have some marketing strategies planned for the year ahead which should lead to revenue increases? Is the coming year one where you need to invest in your business such as a change of venue, new website or education?
As you work through your numbers, you’ll have a clear dollar amount to indicate an appropriate buffer. Your buffer can be grown over time and built slowly. Some quick wins can come from trimming expenses where possible and moving those costs across to your buffer. For example, a number of our clients have decided against maintaining (expensive!) office space after discovering how effective working from home has been for their business, both in terms of expenses but efficiency and productivity. If you have an unexpected windfall in your business such as a dream client falling into your lap, or a significant cost saving, then consider moving parts of these amounts into your buffer.
A common misconception about a cash buffer is that it’s solely for when circumstances have a detrimental effect on your business. While this is certainly a critical purpose of a cash buffer, it can also be a game changer when an opportunity for your business pops up. Having cash ready to go for an invaluable investment gives your business agility. It means your business has the ability to respond to positive circumstances as well as negative- the hallmark of success.
Make sure you check out our Resources Page to find easy to use spreadsheets to guide your processes.