Here comes some advice for all of us to use in business or in our personal lives. But to understand it, we need to delve into the short-and long-term sources and uses of cash.
Good cash strategies to remember
It is tempting to use available cash in good times to build the business and in challenging times to pay the bills and even to outdo competitors in marketing efforts. Those are both good strategies. But there is a tactic that we need to remember that just might save us someday. And it has application to our personal lives as well.
The rule of cash reserves
For our businesses: Once a business has achieved break even and beyond, it should build a cash reserve equal to at least two months’ worth of fixed overhead to protect against unexpected internal or external emergencies, and to allow for your relatively restful slumber at night rather than worry about cash balances. For our personal lives, the same rule applies, with two months’ reserve should be an absolute minimum.
Protecting our “sticky cash”
It’s a good practice to keep that reserve, which we’ll call “sticky” cash, in a money market account, not because of its earnings potential, which is usually so small as to be inconsequential, but because it is visible and requires effort to invade the balance.
How about seasonal businesses or seasonal work?
Seasonal businesses and seasonal personal work are more challenging, and maintaining “sticky cash” is even more important, since it must see you or the enterprise through the low times, long or short. For seasonal sources of income, short term bank loans are an ideal way to augment cash flow and for businesses to finance receivables during high season, always assuming that the loans will be paid off in full—from seasonal receipts.
Matching a loan term against use of funds
If borrowing from a line of credit or any of several forms of loans not specifically created for long term repayment, never use those borrowed funds to buy assets or pay down long-term debt. You will be mixing your short-term asset (cash from the loan) with long term payments. Tempting as that is, the practice—even if used once—can lead to trouble when it comes to repayment of the loan. Always match your borrowing term against your use of funds. And a line of credit should always be considered short term.
Loans for major asset purchases
On the other hand, an extended loan for purchase of a building, car or working asset, should have a repayment term that extends into years of interest and principle payments to match the life of the asset or prevent drain of working capital.
So, remember the source of your cash on hand. And remember the need to maintain reserves, and how to protect them by isolating those reserves in a money market account. And maintain those disciplines always to protect ourselves during hard times to survive the downturns that hit most of us at some unpredictable time in our business and personal lives.
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