Emergency Fund Wisdom
Most good financial advisors will tell you that having a personal emergency fund is just common sense. The recommendation is to have a big enough cash stash to cover your personal living expenses for three to six months. I think this is doubly true for small business owners. Your accountant may tell you that having at least a 2:1 current ratio is also a good guideline, meaning for every one dollar you have in current liabilities, you have two dollars in current assets on your balance sheet.
As a small business owner, I always felt that having too strong of a current ratio was not good cash management. I preferred to take more money out of the business and put it to work in investments earning more than I could get from money market funds or invest it in faster growth either in marketing and/or technology investments. My good friend and competitor Tom Crouser, who is also one of the industry’s top consultants, has always preached having at least a 2:1 current ratio, and I recall debating this point with him. In practice, he was right for most shop owners because very few would be prepared to put money back into the business if they did not leave it there.
What is your risk tolerance?
If you drain the cash reserves in your business too much, this can be risky. Again, if you are a small business owner and you suck too much cash out for personal investments you should be prepared to put more money back into the business in the case of an emergency. Most small business owners fail to deal quickly enough with a period of declining sales, like the loss of one or more big customers.
The result often is becoming unprofitable and sucking up cash until the tough decisions are made to reduce expenses, like fire someone. Another crisis can occur when the big investment is made in new equipment or technology, and the anticipated sales or expense savings prove to be too optimistic. The result again can be cash crisis.