by Tom Grandy
The vast majority of workers in the United States live from paycheck to paycheck. If they lost their job it would have serious consequences in terms of meeting their monthly obligations. Many of us remember 2008 when the economic world came to a screeching halt. Seemingly overnight the economy took a nose dive and many businesses went bankrupt within months. I believe it was AT&T but the situation was not limited to their company. Credit was tight and the statement came out something like this: “How are we going to make payroll since we can’t borrow money?” I was shocked! I was reading about one of the top companies in the country that was going to be in a financial mess because they could not borrow money to make payroll. Some of the greatest minds in the business world worked for this company, and many others like it, and yet they did not have the common sense to build up cash for a rainy day fund …just in case! Amazing.
Poor financial management, which includes preparing for the future, is not limited to the big companies. Small businesses everywhere are very similar to the majority of US workers…they live from week to week when it comes to paying their bills. Most reading this article are in the trades industry. Our industry is notorious for it seasonality. Weather dramatically affects sales for most of the industry. It’s been that way forever and it’s not likely to change. However, what can and should change is how we prepare for the slow seasons.
Many reading this article are Dave Ramsey fans. If you have listened to Dave for very long you will remember his mentioning (as the initial step towards financial freedom) the creation of an Emergency Fund. The long term objective is to have an Emergency Fund that will cover 3-6 months of income…just in case. Guess what? The same principle applies to our businesses. We need an Emergency Fund as well.
How Much Is Enough?
To answer that question let’s use an example. Let’s assume our small business grosses $600,000 per year or an average of $50,000/month. The monthly fixed overhead (overhead dollars that must go out each month to stay afloat) is let’s say $12,000. Adding in salaries of the “key” overhead people (ones that you really want to keep on the payroll at all costs) will increase the number to perhaps $22,000/month.
Utilizing Dave Ramsey’s parameters of wanting a 3-6 month Emergency Fund would mean the company needs to have savings of $66,000 to $132,000 to be on the safe side. “Wow, Tom that is a lot of money!” It sure is. It is unlikely the company will go 3-6 months with NO income so perhaps a more realistic range would be $40,000 to $80,000 in the bank as an Emergency Fund. Now some of you may be thinking, like AT&T, I will simply draw from my line of credit should the need arise. In 2008 that “assumed resource” disappeared. Better to be safe than sorry.
How Do We Generate Cash for the Emergency Fund?
The principle is pretty straightforward. If your rent, insurance, or wages go up, how do they get covered? You increase you pricing to the customer. If you want to create an Emergency Fund of $60,000 then the $60,000 needs to become part of your budget, therefore, part of your pricing. If you were a service company with three techs that means you would produce roughly 3,000 billed hours per year. The hourly rate needs to increase by $20/hour ($60,000 / 3,000 billed hours = $20.00/hour). If your objective were to create the fund over two years then the rate will only need to go up $10/hour. This happens AFTER the Emergency Fund is fully funded. At this point DO NOT CHANGE YOUR HOURLY RATE. The money that was being used to create the fund just became additional profit!
Wouldn’t you sleep better at night knowing you had a fully funded Emergency Fund sitting in the bank, just in case?
