Episode 61: How much savings should I have?

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Here’s a simple rule of thumb. Full transcript below.

Welcome to the Business Numbers Podcast. I’m your host, Ben McAdam. I’m a profits coach, virtual CFO, and entrepreneur, and I’ve created this podcast to help you grow your business profits and understand your business numbers without judgment and without burying you in a whole bunch of jargon that you don’t need. Just actionable tips and case studies to help you grow your business. For show notes, go to the website, businessnumberspodcast.com.

Today’s question is a fairly common one. It tends to come up a lot. The question is: how much in savings should I have in my business?

The exact number depends on how conservative you are. For example, if you’ve got a family and/or a team to support, you might want more of a buffer, but a young single consultant might be more comfortable with less.

Here’s the simple rule of thumb: 3-6 months of expenses saved in a separate account.

You can calculate your monthly expenses by adding up the payments for your bank and credit card statements.

Or you can go into your bookkeeping, look at the profit & loss or income statement report and add up an average of the last couple of months of expenses. Plus any payments you make that are sitting on the balance sheet (rather than listed as expenses on the profit and loss or income statement), like owner distributions, debt repayments, maybe even tax payments if you’re paying down a tax debt.

The important thing here is to take an average over a three month period and pull out any one-off expenses,  for example, if you hire a consultant or hire someone to redo your website for $10k or $20k, then don’t include that in your monthly expenses total when you’re calculating how much savings to set aside.

So that’s the process on how to get the monthly expenses amount. Now let’s talk about how many months is right for you, because I did give a range of three to six months.

Like I said, some people are more conservative than others. Three months is a pretty good minimum and anything more than six months isn’t really effective.

Money sitting in your business bank account doesn’t earn anything, it isn’t doing anything for you. Peace of mind is nice, but maybe if you’ve got more than six months of savings available, because you’ve been conservative, maybe have that in:

  • a liquid income generating asset, or
  • an interest bearing account, or
  • invest it back in your business (pretty good returns there), or
  • pull it out for personal use or personal investments, or
  • make extra debt repayments and save the interest.

But just having it sitting in a bank account is not a very effective use of it.

If you need more than six months of expenses set aside for your peace of mind, then I would suggest that more savings isn’t the solution to peace of mind. There’s probably some mindset work, maybe some journaling or even potentially therapy, to try and uncover what’s the fear there that’s making you uncomfortable. You can’t solve a money-related fear problem with more money, or at least you can’t solve it permanently. It might temporarily give you a little peace, but if there’s fear, or trauma, or something there, you might need to deal with it not by socking away more than six months’ of expenses. So be careful, look out for that red flag. If you find you’ve got six months and that doesn’t seem enough, maybe there’s a different solution you need to investigate.

So anyway, back to the range. That range of 3-6 months, that allows you plenty of time to ride out a 3-6 month period of zero revenue. If all of a sudden all your revenue disappears, or new customers stop coming in (for those of you who don’t have recurring revenue), you can still support your team, not lose the momentum with your marketing, cover your personal draw, not freak out, etc, etc.

However, it’s really unlikely that you’ll suddenly go from your current revenue level to zero revenue. A fairly extreme case would be revenue dropping by half, not immediately to zero. So having 3-6 months of expenses would actually last you longer than 3-6 months.

Let’s say you had three months of expenses set aside, and then suddenly your revenue drops to half. Then really that three months of expenses is going to last you six months, because you’ve still got half the amount of revenue. Possibly even more than six months because you’re hopefully not spending all of your revenue on expenses. So having that much set aside is going to last you more than it sounds like it would.

Plus, after two months of dramatically lower revenue, you’re probably going to start making some changes. You’ll start cutting some expenses. You’ll have half revenue for the first two months, and then you’ll say “Okay, something permanently different is going on here, I’m going to start cutting some expenses”.

Between not going straight to zero revenue and the fact that you will correct course after say two months, then if you have three months of expenses set aside it will actually last you quite a while. It could last you anywhere from 6-12 months. So when I say 3-6 months, for those of you who think that’s a bit too little, it will actually last you quite a lot longer. 

Even though you’ll probably use less than the three to six month buffer that I recommend, it’s handy to have it for your own peace of mind. Knowing that “okay, if what I’m doing this month doesn’t work, the business isn’t going to crash.” It lowers the stakes and it lowers the pressure for you on some of the decisions you make, which means that you can be a bit more aggressive. In some of the decisions you make, you can swing for the fences. And if it flops, it’s okay, you can correct course. You can take a week to feel sorry for yourself, and then start working on something different, or go back to the way that worked in the past.

Having those savings, reducing the stakes, reducing the pressure, and giving you peace of mind, it will improve your business in a surprising amount of ways, having it there.

A bunch of you listeners have probably gotten to the stage where your business grows to a point where you start feeling uncomfortable with how much money has to go out of your business every month. Maybe your team, your payroll, starts hitting a certain size, and you start feeling the pressure of having to generate enough revenue (and having to generate it reliably for some time) in order to support those team members and to not have that uncomfortable “OMG, I’m not gonna make payroll” moment.

So it’s handy to have that savings buffer. That is what will partially help deal with that uncomfortable feeling when there’s a huge amount of monthly recurring expenses. But that feeling will pass over time anyway. You kind of get used to it. I remember an example, very early in my career. The first time I had to do a $50,000 transfer. I was paying bills and one of them was $50,000. The first time I did that, I triple checked, quadruple checked, quintuple checked, sextuple-checked that I put in the right bank details and that I was supposed to be paying them that amount, and that there was enough money in the account. It became very nerve-wracking, but within a couple of months I was comfortable with it.

And so the similar thing happens with you. You’ve got $20,000, or $100,000, $200,000 a month in payroll and you think, “Oh my God, how am I going to do this? This is more per month than I used to earn in a year. And my trick of running a quick promotion isn’t going to work, with all that pressure.” Having some savings will help combat those feelings, though the feeling will pass; you’ll feel the same about it when your pay gets to 50k and then at 150k, you think, “Wow, why was I so worried? This 150k, that’s pressure.” And then you get used to that and business grows some more and it’s always a self-development journey. Being in business always brings you up against your comfort zones.

Anyway, we’ve been talking about having a 3-6 month buffer, but often finding it’s probably more than you need in practical terms, i.e. when you actually go to use it, it will last a lot longer than that, but still it’s useful for a peace of mind.

But even though you’ll probably use less, like I mentioned, it’s really handy to have a war chest of savings ready for those short term, amazing opportunities that turn up. Maybe you go for six months of monthly expenses as a buffer, and then you think to yourself, “You know what? I didn’t feel any more calm than I did when I had three months worth of expenses.” And then a last minute opportunity to sponsor an event comes up and because it’s last minute (say another sponsor pulled out), the sponsorship rate is a lot lower than it normally would be, so you get a great deal. Or maybe there’s a potential acquisition that is available and the business owner is happy to sell it at a low price if the transaction can happen fast, if you have cash available and don’t have delays while you organize funds with lenders or investors. So having a war chest of savings there is helpful.

Aiming for three to six months is still a good goal, even though, like I’ve said, you probably won’t end up using that whole amount when the time comes.

Then one other point I want to leave you with is that behind this question of “how much savings should I have”, there’s another question that’s related or underneath: “will I have enough money IF… ?” That’s the question. 

  • Will I have enough money if my revenue tanks?
  • Will I have enough money if my revenue goes to zero?

That’s the real underlying question: will I have enough money? 

A more comprehensive answer to that question is to use a cash flow projection. A cash flow projection looks a little bit like a profit and loss or income statement, but it’s all about the cash moving in and out of the business.

It’s got some extra things on it that the profit and loss doesn’t. It might be a little different to the profit and loss in the sense that instead of revenue, a cash flow projection will show cash coming in. So it’ll be “payments from customers” as opposed to how a profit & loss might instead show invoices generated, not actual payments from customers. And then the expenses that you actually pay money for, they’ll be on the cash flow projection in the month when you pay for them, not when you get a bill from a supplier. There’ll be payments to your team, payments for software, all the usual expenses.

Plus there will be debt repayments and your draw because those things reduce the cash. They’re not technically expenses that you would find on a profit and loss, but they would be included on a cash flow projection. And down the bottom of the cash flow projection, you have a total of the net cash in or out of the business. So does your bank account balance go up by 5k in this month, or does it go down by 50k or 100k during the month?

Then there’s another total down the bottom that estimates what your bank balance will be at the end of that month. And so you can answer a lot of “what if” questions:

  • “Is my bank balance looking healthy six months into the future, if I hire this expensive rockstar?”
  • “Or what about if I invest in this big marketing initiative or double my marketing budget because that seems to be working and I want to level up my business?”

You can actually see whether it’s going to send you broke six months from now, or 12 months from now, with a cash flow projection. Though more than six months out can be a bit unreliable if you haven’t had experience using a cash flow projection, because we all suck at predicting the future in the beginning. 

Anyway, before I start teaching you how to do cash flow projections and why they’re valuable and all that kind of thing, I’ll save that for another podcast episode, if you’re interested. But my point is that a cash flow projection gives you a more comprehensive solution to the “will I have enough money?” questions that come up in business often. “Will I have enough money if I stretch my budget and hire this person, or invest in this marketing thing, or acquire this business, or draw out more money so I can invest in this other thing, or pay down my debts?”

The three to six month buffer is a great way to give yourself peace of mind that you will have money if things go really bad on the revenue front. But it doesn’t necessarily tell you “can I afford to hire this person?” You might be able to think “Well, I’ve got a buffer if things go really bad, so maybe I can dip into the savings to hire.” I did a podcast episode on that a few episodes back, “Should I dip into my savings to hire?”, that was episode 54, if you’re interested in that. 

So you could use your buffer to help answer that question, but a cashflow projection is a more comprehensive answer, because yes, you’ve hired this person, and then another opportunity to dip into your savings might come up, so layering them all gets a bit more difficult to think through. And so having a cash flow projection will help answer those questions. 

So, quick recap:

  • “How much in savings should I have as a buffer?” Let’s say three to six months worth of expenses.
  • “Will I have enough money if…?” Build a cash flow projection and use that. 

I hope this was helpful. As always, if you have questions, reach out, I’d love to feature them on a future episode. Otherwise, thank you for listening.

Before you go, two quick things:

  1. If this was useful, please give it a review and share it with a friend who it might help.
  2. If you want help from me to unlock growth and profits, and greater clarity around your numbers, book a call through ProfitsCollective.com and if we’re not a fit I’ll point you in the right direction. 

Thanks again for listening.

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