Building a Cash Reserve

Part B: Understand the Money

Say you run a cleanup or contracting crew, and every Friday depends on whichever customer paid that week. Work is coming in, so the business is not failing. The problem is what happens to the money when it arrives: a check lands, it goes out again, and there is never anything left in a reserve. Some weeks that works and some weeks it does not.

Now change one thing. Take a fixed share of every job and move it into an account of its own before you touch the rest. The pot gets drawn from when it must be, and it gets refilled by the next job.

We see this pattern a lot with crews and contractors, and the shift is bigger than it sounds. You stop steering by whatever landed in the account that day and start steering by a plan, because the reserve buys you time. Two words are worth knowing here. Your burn rate is what the business spends in a typical stretch, and your runway is how long your cash lasts at that pace. We will measure it in weeks of cash: your cash divided by your average weekly spending.

Profit is a report, reserve is a cushion

A profitable month tells you the work was worth doing. A reserve tells you that you can survive a month when the timing goes against you: a customer who pays late, a slow season, a truck that dies, a job that goes wrong. If you have read Working Capital and the Cash-Conversion Cycle, you know you spend before you collect. A reserve is what covers that gap without panic.

Notice the order. Nobody waits until they feel rich enough to save, and nothing is ever left over on its own. The portion comes first, from the top of each job.

Working out your own target

Your target comes from your own costs. The way to find it is to measure it in weeks of cash, not in dollars pulled from the air.

• Step one. Add up what it costs to keep your business running for one normal month if no new money came in: payroll, rent, insurance, vehicle and equipment payments, software, the minimum you need for materials and marketing, and your own pay if you take it (see Owner Pay Versus Business Money).
• Step two. Divide by four (or 4.3 to be exact) to get roughly one week of operating costs. That is how fast the business burns cash when nothing comes in.
• Step three. Multiply that by the number of weeks you want to be covered. Four weeks is a fair first milestone. Seasonal businesses will want more, and so will anyone whose customers pay slowly. Over time, many owners work toward a few months of fixed costs, and your forecast will show you where your own number sits.
• Step four. Decide how much of each job or each deposit will go into the reserve, and by when you want to arrive. Pick a share you can afford out of each job’s profit. For a business netting 10 percent, a flat 15 percent of revenue is impossible, so look at your margin first.

A made-up example. Say your monthly operating costs come to $20,000. Dividing by four, one week is $5,000, so four weeks is $20,000 and six weeks is $30,000. (Dividing by 4.3 gives about $4,650 a week, so the exact figure is a little lower.) If a job brings in $12,000 and your margin lets you set aside 5% of the revenue, that is $600 into the reserve. It takes a number of jobs to get there, and that is fine. The habit matters more than the speed.

Some owners in seasonal work will want more cushion, and some with steady, prepaid work may need less. Your 12-month forecast shows how low cash actually gets, which is a better guide than any rule of thumb.

The rules that make it work

Keep the reserve in a separate account, not a drawer and not the operating account, where it will quietly get spent. Decide what counts as an emergency before the emergency arrives, and write the definition down. A slow Tuesday is not an emergency. A missed payroll is. When you draw from it, put it back as your next priority.

The next payment that comes in

Work out your monthly operating costs and turn them into weeks of cash. Open a separate account, even if it starts with a small amount. Then decide the share you can afford from each job’s profit, and take it out of the very next payment that comes in. The Resources page has a Cash Reserve Target Worksheet that walks through the arithmetic.

What it costs

Two to three hours to add up your costs and set up the account. After that it is a few minutes per job. There is usually no cost to open a savings or second business account, though it varies by bank. The real cost is patience, and money set aside is money you cannot spend elsewhere, which can pinch on a thin margin. Start small and build.