In the last two weeks, my stock portfolio dropped significantly in value, and I don’t care. Why? Most of my stocks are dividend paying and thus far at least, the dividends haven’t been cut. What matters is the cash they’re generating which I depend on for a part of my income. That hasn’t changed. Also, I’m quite a ways from retirement, so I can sit tight and wait for the next upswing. The cash generated through dividends is more important than the value of the underlying stock. Cash is king.
You may have heard that old saying. Basically it means that cash is more important than the value of assets or even your profits. And most of the time it is.
Here’s another example. I bought a house with a 30-year fixed mortgage. My mortgage payments were not going to increase. I worked my monthly payment into my budget, and I knew, based on my income, that it was affordable as long as my income didn’t decrease — not likely. Then, the Great Recession of ’08 happened. My house dropped significantly in value and I didn’t care. Why? My monthly payment remained the same, my income remained the same, and I wasn’t going to sell my home anytime soon if ever. The value of my house didn’t matter and I knew it would go up again eventually because it is in a great neighborhood. And it did.
Cash for Your Business
What is a cash flow statement? It’s cash in less cash out. If your business is cash flow positive every month (more money is coming in than going out), you’ll be okay.
What is an income statement? It is revenue or sales, less expenses. The result is your monthly profit or loss. You can operate at a loss for a period of time, and as long as you are cash flow positive, you can still be okay. Here are some suggestions for how to manage your cash flow in a business:
- First of all, you might ask how you can be cash flow positive while still operating at a loss. Usually it’s because you can borrow money or raise money by giving away equity in your company. As a side note, some income statement “expenses” do not result in cash going out. An example is depreciation. This is when you write-off fixed assets like a computer, for a specified amount of time (established by the IRS) but you’ve already paid for it, so it doesn’t result in cash out after the initial outlay.
- Most startups operate at a loss. Their sales haven’t caught up to their expenses. So raising money is the difference between a pipe dream and a viable business. Money can be raised from friends and family, an angel investor, or your own savings. But, it has to come from somewhere.
- Let’s say you decide to start a company to develop a revolutionary app. You have to find and pay programmers. You need to rent an office where they can sit, and office furniture to sit on. Maybe you buy a coffee machine so they can stay up late at night working. You will have to pay utility bills — electric and internet connection. Assume most of your programmers are subcontracted, but a few are employees and you will have to pay their payroll taxes and benefits. For our hypothetical example, suppose all of that adds up to $60,000 a month. That’s called your burn rate. You don’t have any sales yet because it takes eighteen months to build your app and test it. So your loss for your first year would be $60,000 times twelve months or $720,000. But you could still be cash flow positive. How? You sell 25% of your company to an investor for $1,080,000. That gives you enough money to make it to the point where your app is finished and you can start selling it. Things rarely work that smoothly in the start-up world. Maybe half way through it becomes apparent that it will take a full two years to finish the app. Then, no one buys it at first, so you have to hire a team of marketers. There are expensive Google adwords you have to buy. Even with your crack marketers, your app sells at a much slower rate than you anticipated. Although you were able to end your contract with most of your programmers, you have marketing and sales people to pay, and now you have to hire a bookkeeper. In the Startup Founders group where I was a founding member, I’ve seen all types of unanticipated problems. They are usually the result of founders being unrealistic about how much money they need to spend and how much money they will make. At that point, they have to go back to their investor, or find another investor and raise more money. If the founder can’t find more money, they close up shop.
- Another big mistake I see is when a company is making an actual physical product and they have minimum order quantities (MOQs) they must buy. I wrote about this in another article called, “The Art of Pricing.” In this case all their cash is tied up in their products or their inventory. They think they’re going to sell everything and then they can’t. Let’s assume it is an apparel company and to make shirts with this really cool fabric, they have to buy, say, 2,000 yards of said fabric at $8.00 a yard. They’re making ten different styles, and all of a sudden they have $160,000 invested in inventory without enough orders to recoup that money. And that’s just for the fabric. They also have to pay the sewers. If they can’t sell those products in a hurry, they have to close up shop. Don’t buy products or the raw materials to make products unless you have orders for them. Or find raw materials (fabric in this example) that don’t have large MOQs.
- Construct a realistic set of projections so you really know how much money you need to run your business. If you don’t know how to put together monthly and yearly projections, hire a consultant or an accountant. It shouldn’t cost that much and could make the difference between making it or not.
- If you are making and selling products, you can use a factor. A factor is like a bank, but instead of loaning you money secured by collateral, they actually buy your receivables. They will loan you between 50% to 80% of the value and then pay you the rest after they collect the money. It’s a bit pricey (they charge from .5% — 2% of the invoice value plus fees and sometimes interest), but it’s worth it if you need the cash. That way you can pay your vendors the day you ship instead of waiting for the store to pay you. Stores usually take thirty days to 120 days or more to pay you.
Cash for Your Personal Life
As far as your personal life, there are several ways you can make sure you have adequate cash on hand for emergencies. Here are some tips:
- Just like projections for your company, make sure you have a reasonable budget and stay within its constraints. If you can’t live on your income, then you have a different problem. You need to either spend less or make more. It’s kind of like a diet. The only way to lose weight is to eat less and/or exercise more. Same goes for your living expenses.
- If you buy a house, the first thing you should do is set up an equity line of credit secured by a second on your house (as soon as you can do it). If you have spare equity, which is the value of the home compared to your mortgage loan, it is pretty easy to arrange. You will have equity in your house if you make a down payment. After you arrange the home equity line of credit, don’t borrow against it. Just sit on it in case you have an emergency and you need the cash.
- I also have at least several credit cards on hand for extra cash. All but two have a zero balance and I keep it that way. If I have an emergency, I can use the credit cards. I have done this from time to time, and then I pay them off as soon as possible.
- Save money for Pete’s sake. You should have at least three months salary on hand in case you lose your job or have some other emergency. Things always happen in life that you don’t expect. Expect the unexpected.
- Try to decrease your expenses. Look at your personal monthly burn rate. Are there things you can cut out? Can you walk or run outside or ride your bike? Do that instead of joining a pricey gym. Make coffee at home instead of going to a coffee shop. Take a stay-cation instead of a vacation. Buy a cookbook and learn to make good meals at home instead of going out to eat. Make dinners out a once a month treat. Don’t buy something unless you really need it. Clip coupons for the grocery store. For me? It was gifts to my children that I was always splurging on. I established a reasonable limit on that and focused more on thoughtful gifts than expensive gifts. They still love me. There are a million ways you can decrease your monthly expenses. Get creative and get going.
- This one is related to number two and there really is more than an ounce of truth to this adage: you should borrow money when you don’t need it because when you do need it, you can’t get it. Think about the fact that money is loaned only if you have collateral — or assets of some sort to back it up. You really only have assets when you are doing well — a home, stocks, savings, retirement accounts. Once you have the money, you can sock it away. Sure, you’re paying interest on it, but interest rates are ridiculously low right now. Sometimes banks will cancel lines of credit or reduce credit card availability. But if you have cash in the bank, they won’t take that away from you.
- If you’re in a bind, get a second job. This won’t last forever. When I’m running and tired and don’t know if I can make it to my goal of six miles, I tell myself, it’s only for an hour. I can do anything for an hour. Tell youself the same thing whenever you have to undertake a difficult task, like working a second job.
The bottom line is that you want to always have cash on hand one way or the other for both yourself and your business. Cash is king.