According to a study published by Bankrate in 2023, 2 in 3 Americans would be worried about having enough emergency savings to cover a month's worth of living expenses.

Three years prior, in 2020, United States Federal Reserve banks published a separate study called the Small Business Credit Survey that stated that 56% of small businesses have relied on personal savings, friends, or family to fund their businesses in the last five years.

43% of companies had trouble paying operating expenses.

This data was collected in 2019, before the profound impact of the COVID-19 pandemic that sent a shockwave through small businesses around the world.

Can small business owners, who represent almost half of the private-sector workforce, who are deeply embedded in the fabric of local communities, who overcome constant challenges and obstacles daily, create a safety net that can bring them financial confidence?

I believe we can. You just need to know where to start.

[Intro music]

Welcome back to The Profit Plot, a podcast where we help small business owners unlock the story behind their profitable business by unpacking one complex financial topic at a time. I am your host, Jeremy Millar.

Financial emergencies often come without warning. They are as swift as they are devastating.

If you listen to any personal financial expert, you'll likely be familiar with emergency fund savings and budgeting. These tools are often the best resources for anyone beginning their journey into financial freedom because they allow you to survive a financial emergency without going into debt. They teach the responsibility and discipline of creating a safety net for yourself!

Unfortunately, emergency fund savings and strategic budgeting are tools that many business owners rarely implement.

Instead, we find small business owners who are forced to rely on their personal finances or the support of friends and family to weather an unexpected storm.

Indeed, businesses are typically far more financially complicated than individuals. Your company likely has a greater volume of expenses, abstract concepts like payroll liabilities, and a constant cash inflow and outflow. Very few individual households have household employees, whereas small businesses employ almost half of the private-sector workforce, as I mentioned before.

Still, your business should have an emergency fund that it can draw from in times of need. It's a tool that allows you to have peace of mind, to separate yourself from the business, and to grow faster.

How do you know what your emergency fund should look like? What's the right balance between money earmarked for reinvesting into your business and the money you need to cover payroll?

Business finance can get muddy. It's not always as cut and dry as we like, and it often depends on your business's specific quirks.

Still, managing your cash flow is essential for small business owners everywhere. Monitoring how cash moves in and out of your business allows you to know whether or not you can pay your employees, cover expenses, or take a distribution of profit.

The amount of money your business has in the bank, your bank balance, fluctuates daily depending on what comes in and goes out.

This is where accounting has real-world implications.

You need excellent bookkeeping to understand where your money goes throughout the week! It's not enough to glance at your Chase app and think, "huh, the number went up."

Instead, you should track in detail the way that your money moves. You need to understand your monthly burn rate, the amount of money you're taking in minus the money being spent, to know how much you need to keep in the bank.

Everyone needs a nest egg.

An amount of money you keep in the bank to cover your operating expenses and then some. Some business owners can get away with having just 30 days of cash in the bank. In my experience, 60-90 days of cash is even better because it allows you to make a course correction if your business starts to lose revenue.

If my business is spending $50,000 per month, ideally, I'd like to have at least twice that in the bank to ensure that my expenses are covered at all times.

This largely depends on the nature of your business, though. Perhaps your business requires you to make large purchase orders every 3-months to keep inventory on hand. Or, maybe your sales team is entirely commission-based, and the amount you pay fluctuates according to their production.

These nuances can change the amount of cash you may feel comfortable keeping in the bank at any given point in time.

On top of the balancing act of determining the amount of cash you need in excess of your operating expenses, it's important to consider the opportunities for growth that money can provide.

If you're suddenly handed an opportunity to recruit a high-performing team member, having cash on hand ensures you can pay a handsome signing bonus. If you're ready to develop a new product and need a larger R&D budget, you can be your own funding source!

Instead of coming up with an arbitrary figure for how much money you'd like to have in the bank, sit down and do the math. Consider the seasonality of your business, any debt obligations that you may need to continually honor, and build a forecast for how your business might grow.

Think about the age of your business - have you been around for decades, or are you just a few years old? How volatile is your industry? Is your equipment constantly breaking down and in need of repair, or will it be soon?

After considering the operational needs of your business and the industry at large, it's much easier to evaluate the amount of cash you need on hand at all times.

Identify your average monthly expenses and the rate at which your cash cycles in and out of the business. From there, you can calculate an emergency fund figure that you'd like to keep on hand - something that will stay in reserve regardless of the growth opportunities that come up.

After you have this figure, identify how much money you'd like to leverage to reinvest into the business. This amount will be best suited in addition to your reserve funds. Separating the two affords you the opportunity to invest in significant growth while still maintaining your nest egg in the case of an emergency.

As I mentioned before, a balance must be struck here. You've got to keep your business liquid - able to cover expenses and unexpected payments at a moment's notice - while keeping the opportunity for growth alive.

A business's financial life is incredibly dynamic; it's constantly changing and evolving, so you need to adapt rapidly. Working with an experienced financial advisor, accountant, financial coach, or fractional CFO can help you make informed decisions about your business's reserve.

Is it best to draw upon a line of credit when making large inventory purchases? Are you able to invest heavily in a new ad campaign that could 10x your growth? Can you as the business owner take out profit distributions?

While 43% of companies in the US may have trouble paying their operating expenses, you have an opportunity to be part of the 57% that won't. Your business can grow, weather any storm, and continue to expand with the right reserve.

This kind of safety net is not formed overnight and is only accomplished through a great act of discipline. It may require you to set aside money instead of taking it out of the business in the form of profit.

Ultimately, it will create a stronger, more resilient business than before.

As we wrap up today's episode, I want to leave you with a few pivotal thoughts.

Building a financial safety net for your business is akin to laying a firm foundation for a house. Without it, even the most majestic structure is vulnerable to the elements.

Your business is no different.

With discipline, planning, and a clear understanding of your financial landscape, you can navigate any storm, seize growth opportunities, and enjoy the peace of mind that financial stability brings.

For those of you who've been in this situation, I'd love to hear from you.

How have you managed your reserves? What challenges and successes have you experienced in balancing growth and security?

As always, thank you for tuning in to The Profit Plot. Make sure that you're subscribed to The Profit Plot podcast on Spotify, Apple Podcasts, or wherever else you get your podcasts from and share this episode with a fellow entrepreneur.

Let's elevate our community's financial literacy and stability, unlocking the story behind our profitable businesses. Looking forward to having you here with us next time, on The Profit Plot.