In Part 1 we recognised some recurring errors made by small business owners being –
- The failure to maintain sufficient cash reserves, and
- The failure to adequately reinvest back into their business.
We continue with a story from my business history…
When I started my first business I experienced a surprise near business ending event within the first six weeks! It was a highly stressful time. But a couple of early decisions meant the difference between surviving and going into bankruptcy.
First, I had to buy a new car as prior to that living close to St George’s Terrace and working in the city meant my partner and I shared just the one.
While my heart said “new beemer” my head said “cheap and cheerful”.
Instead of borrowing to buy a flash new car, which yes would have looked good when I visited clients, instead I paid cash, no borrowings, for an inexpensive used family sedan.
While I admit my choice of car potentially impacted the impression I gave when visiting clients (I did receive comments that clients wanted their adviser to drive something better) retaining it for the first six years of business meant I never experienced the unnecessary cash flow drain of loan repayments and instead was able to reinvest into my business at a crucial time.
Second, modest living arrangements meant similarly modest disposable income needs.
My partner and I remained in our small townhouse we had bought in our early 20s while paying a very modest mortgage.
While we of course dreamed of moving into something bigger and more luxurious, holding off as long as we could saved the business from strains it otherwise may not have been able to weather (particularly during the GFC).
So how much cash is enough?
Well as a starting point, ask yourself, on your most recent pay day (as in the day you paid your staff) did you have enough cash in the bank to not only pay your staff their net wages but… did you also have enough cash to pay the Pay As You Go Withholding AND the Superannuation as well?
If the answer is no then that is a real concern.
That means you are hoping to pay this week’s expenses with next week’s revenue (assuming it comes).
If this is your business then I have grave concerns for its future.
What about at the end of your activity statement period…
Do you have the GST you collected for that period available in the bank ready to pay the ATO?
We all know the GST we collect is effectively not our money.
Yes we get to offset input tax credits and therefore keep some of it, but nevertheless if you don’t have at least the net amount of GST you now owe in the bank, then you are effectively borrowing from the ATO to fund your business day to day.
If you are on an ATO Payment Plan then things are even worse and on the verge of spiraling out of control.
In an ideal world my advice would be to aim for at least one month’s expenses in the bank.
For a business turning over $1m with a profit margin of 20% that equates to around $66,000 minimum retained at all times.
If you are a fair way off that, maybe as a starting point aim for two fortnight’s gross wages (including super) plus one month’s rent and then build from there.
What about my overdraft I hear you say?
Well look it is certainly handy to have for a rainy day, but all of the most successful businesses I have worked with over the years never lived out of their overdraft.
It was there as a buffer and for short term bumps in the road or new opportunities.
The most successful businesses retained a positive cash balance on an ongoing basis meaning they could remain flexible and were never boxed into a corner.