Create a Safety Net: Next Steps to Financial Success in Business

November 16, 2015

This is part three in a series on An Achievable 10-Step Plan for Winning Financial Success in Business

In part two of this series, I talked about the first four steps in a 10-step process, a roadmap, designed to help guide you on your path to building a financially strong, wealth generating business. Those steps were designed to help you get up close and personal with the financial reality of your business.

In this post, I’ll walk you through steps 5 – 7. This is the phase I refer to as creating a financial safety net for your business.


Create a Financial Safety Net

Wikipedia says a safety net is “a net to protect people from injury after falling from heights by limiting the distance they fall, and deflecting to dissipate the impact energy.” A safety net helps the circus performer on the high wire avoid death (and protects the audience from watching them splat on the ground) if they make a mistake during a performance.

The safety net also frees up the performer to take more chances. They can learn more difficult and advanced “moves” knowing they are protected from the inevitable falls that come with learning and experimenting. That way they can put on an amazing performance for their audience.

In business, a financial safety net is created by having some money (cash in the bank) and less debt. And it provides you the same two benefits: it protects you when financial surprises hit (avoiding the splat on the ground) and it allows you to take measured risks (learning and experimenting) to grow your company.

A financial surprise could be a sudden reduction in sales, a large customer that pays their invoice late, or an unexpected expense that blows a hole in your budget. Without a safety net, you have to scramble to avoid disaster or embarrassment with vendors or employees. With a safety net, you simply deal with the surprise and move on. No drama. No losing sleep.

Taking a measured risk could be hiring that new sales manager you think can double sales. The risk is the new sales manager might not land any new sales. You might lose money because you are paying them a base salary to get started. It could be a total flop. Without a safety net, you might have to reduce other expenses to make up for the shortfall. Or you might have to borrow money just to get by. With a safety net, you know in advance that if the worst case happens you can live with it. You can write the check and move on. No drama. No losing sleep.

These three steps will help you build a financial safety net in your business.

Step 5: Pay your bank line down to zero (even if it’s temporary).

A bank line of credit is a financing source intended to help a business meet seasonal or short-term cash needs. It generally establishes a fixed amount that the business can borrow during the term of the line. Then you draw or pay down on the line as needed.

A good example would be a company that carries inventory and whose sales are highly seasonal. Ahead of the busy selling season they have to increase inventory levels. The bank line can be drawn on to fund the inventory purchases. As the seasonal selling comes to a close, and the increase in inventory has been sold and converted to cash, the company can pay down the line. They had a temporary need to borrow money and the bank line gave the company the flexibility to meet its cash needs.

The problem is that many businesses borrow on their bank line for other than temporary cash needs. Sometimes it’s used for capital expenditures. Sometimes to fund losses. Sometimes to fund owner distributions. The availability of cash from the line can easily lead to decisions that have serious consequences later on.

The discipline of forcing yourself to pay off your line of credit at least once a year (or more) will help ensure you are using the bank line the way it was intended.

Step 6: Reduce your personal guarantees (begin the process).

Most businesses are run inside a legal entity like a corporation or Limited Liability Company (LLC) in order to provide some liability protection for its owners. Legal entities have assets and liabilities separate and apart from those who own the entities. A personal guarantee is you agreeing to take personal responsibility as an owner for a specific debt or obligation of the business. So if the company files bankruptcy, or fails to pay the obligation, you are personally responsible to make the payment.

Most entrepreneurs and business owners rarely consider how much they have personally guaranteed. And they are shocked at the total dollar amount they are personally responsible for.  One reason the number is so surprising, and so big, is because the guarantees have occurred over a number of years as the business has grown.

You finance some new equipment and the loan requires you to sign a personal guarantee. You sign a new lease or renew an agreement with an important supplier and a personal guarantee is part of the deal. Over time, as your business grows, the amount of obligations you've guaranteed goes up.

But as you grow your business and become more successful, it’s wise to think more strategically and thoughtfully about how you handle personal guarantees. You do that in two ways. First, quantify the amount of your existing guarantees. Here is a format to help you list and quantify your existing personal guarantees.

Second, slowly begin reducing the number of guarantees. One of the best places to start is to refuse to sign any new vendor or supplier guarantees. Most vendors put the guarantee on their credit form but that doesn’t mean you have to sign it. They will almost always set up credit with the business as the only responsible party.

Step 7: Build your cash balance to 3 months of operating expenses.

Building your bank balance to three months of operating expenses has two key benefits. First, it creates a financial cushion against surprises or downturns. Second, it provides “dry powder” that allows you to take some risks to grow your business or jump on a unique business opportunity that might come your way. It provides some “risk capital” to use as you grow your business. It’s an important part of creating your financial safety net.

It also lessens your need to borrow money for otherwise small purchases or capital expenditures. You can become your own bank for more of your month-to-month financial needs. A strong cash cushion also sets the stage for you to implement Step 8 in the roadmap to building a company that is strong financially.

Creating a Financial Safety Net is Wise

Creating a financial safety net provides you two important benefits: it protects you when financial surprises hit and it allows you to take measured risks (learning and experimenting) to grow your company. It is one of the secrets to building a business that can survive and thrive over time.

In my next post, I will walk through steps 8 – 10. This final phase is what I refer to as growing and enjoying financial success in your business. Remember, it’s very important to create “happy owners” in the business. Enjoying the financial rewards of their ownership in the business is a big step toward creating happy owners.

cash management guide

Topics: Business Best Practices, Accounting & Finance

Philip Campbell

Consultant, Author

Philip Campbell is a CPA, consultant, and author of the book A Quick Start Guide to Financial Forecasting: Discover the Secret to Driving Growth, Profitability, and Cash Flow Higher. This new book provides a straightforward, easy-to-understand guide to one of the most powerful financial tools in business: a reliable financial forecast. He is also the author of the book Never Run Out of Cash: The 10 Cash Flow Rules You Can’t Afford to Ignore. The book is a step-by-step guide for business owners and managers who want to better understand and manage their cash flow. Since 1990, Philip has served as a financial officer in a number of growing companies with revenues ranging from $5,000,000 million to over $1,000,000,000. He has been involved in the acquisition or sale of 33 companies (and counting) as well as an IPO on the New York Stock Exchange. Philip loves helping entrepreneurs and business owners think strategically about the financial side of their business. His consulting work is focused on providing the financial insights that leaders need to increase profits, improve cash flow, and enjoy the fruits of financial success in business. What really sets Philip apart from the average financial person you meet is his passion and excitement about helping entrepreneurs and CEOs take control of their cash flow. In fact, early on in his career, he focused and “preached” so much about the importance of cash flow that people now call him CASH. Philip is the founder of Financial Rhythm, a website devoted to people who are serious about creating financial health, wealth, and freedom in their business. If you're an entrepreneur or business owner, Financial Rhythm is a place to get simple, actionable strategies for creating a financial future that is bigger and brighter than your past. Philip lives in Austin, Texas. You can email Philip at pcampbell@pdq.net.
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