Mastering Business Finances and Reserve Cash Flow

Now more than a month in your operating account, that's when I think that can get a little bit. Can actually get a little bit dangerous because it can make entrepreneurs start to feel fat and happy. Some will take their foot off the gas, some will overinvest in things without doing it. So I like about a month in operating now, outside of that, I do think it's important to have some type of a rainy day fund, emergency fund that, that type of savings. And I do think that in the aggregate, all companies should seek to have three months of operating expenses. And I would mean that like true operating expense. So you can take out your variable. Like, so this is if everything just. You can take out a lot of your variable expenses. So, you know, so I mean like fixed your fixed operating. So your payroll, your rent, your stuff that you're going to have to pay, that's contractual. That's just absolutely the right thing to do. If everything goes horribly wrong. If you lose your merchant account, you can't do whatever. Well, you, you could turn off ads.

Hey, everybody. Welcome to the Business Lunch podcast. I am one of your co hosts, Roland Frazier, and my good friend Ryan Dice is your other Ryan. How you doing today?

I'm doing absolutely wonderful. How about you? What you doing? What you up to?

I am doing great. I have for the first time, I was telling my wife this over the weekend. I have for the first time in I don't know how long, but many, many months, possibly a year. Nothing on my calendar that I am dreading doing for this foreseeable month. The whole month of June, when we're recording this here at the beginning, usually there's some big giant frog to be eaten, like this just thing that I don't want to do, whether it's an event or a trip that I don't want to take for business or, you know, some big document or conversation, like, you know what I mean? Like, there's, there's just. It seems like. Or I've got to build an entire product, you know, and that's completely not. None of those things that I am not excited about are on my calendar, which makes me very, very happy.

I'm glad that you. Well, I'm glad that you acknowledged that because I think it's good our Personas, right? Like the characters that we put out there on the interwebs. We're very big on lifestyle and on freedom and all those kind of things. But I think it's also important to acknowledge that it's not a perfect situation, like very often because Business is not always this perfect thing. Very often we get pulled back into the day to day as much as we fight, as much as we battle, and as hard as we work, and as much as we talk about the importance of building systems to exit the day to day and that, that is our normal, you know, I would say we get it more than most. It's not always. And so I think it's just, I appreciate you acknowledging that because it's a good reminder, I think for everybody out there that if that's what you're feeling, there's a lot at the end of the tunnel. And also if you've been there and you found that you got sucked back in, it doesn't mean that you're like fundamentally broken. It just probably means that you're, you know, you're growing.

And so we, we talked about it, I think a week or two ago that Bezos, Jeff Bezos said, you know, you're doing really great, fantastic, if you like what you're doing half of the time. And you and I were like, you know, I don't know, I mean, I did like, I didn't like it. But there's always stuff that you don't like. Yeah, particularly not even just like getting pulled back into the business, but just, I mean, as a function of what we do, like if we're buying a business. I hate the agreement. I hate the agreement part. I love the negotiation and I love the strategy. But when it comes to actually reading a 75 page document that's got mostly legalese that you have to read, I just absolutely can't stand it. And I don't even like, I think I actually owe you an agreement template that I just haven't got, which I, I will send that to you today. But like that, you know, the, on, like this is the contract that we use to sign people up and I, and I'll have somebody that agrees to do it and it's like, you know, they're going to pay a lot of money and, or give you part of their company or whatever. And then I just don't like that document part. I love the conversation. I'm excited about the relationship. I just don't like that document. And I love the result of creating product but recording videos. You and I talked about this too. One of my least favorite things to do, you know, just sit down and turn on the lights and you know, get ready to read for three hours. You know, it's so, so yeah, it's, it's, I think having so many things Because I wouldn't look at any of those things as us being sucked back into the business as much as it's just like as part of what we do to own those businesses and make them successful. And because we have a whole bunch of them, there's pretty much always one of them that needs something like that. That's not a, you know, not on my checklist of happy that has to be done. So it's, it is rare to get a place where there's not something like that. And it's very easy if you watch the movie Click. That came out a long time ago with Adam Sandler where he could fast forward 10 seconds in the future and he would skip all the stuff he didn't like. And he ended up skipping like years and years and years and missing out on everything and regretting that in the end. It's very easy for us as solution, productivity oriented people to look at what we have to be to get done and be excited to have it done. And so I've been in a little bit unbalanced mode towards that of like, you know, man, I'll tell my wife, you know, I got that conference next week and I'll be really happy once we have that done. And then after that I've got to fly to this place and do that. And as soon as that's done that, that's going to be good. And then three more things come on the calendar and you know, it's, it is easy to get in that. And so one of the things that I've, two New Year's resolutions I had now we're, you know, about halfway into the year. Right. One was to use more of the things I already have, be it membership at a club or you know, a, a musical instrument I'm not playing or you know, or, or something an app on my phone that I paid for to do that. And the second was to do more to get more things in that are not work related. Even though I really like work and enjoy it. I think that having non work things that you're focusing on too can be really important. So not the topic of this thing, but definitely something that you asked me and I didn't give you the everything's going fine, Ryan answer. I gave you the.

Yeah, well, we never do.

Right.

I mean, I feel like every time we ask that, you know, we try to answer it honestly because there's times when things are absolutely amazing and there's times when things could frankly be a hell of a lot better. And I think that's called life. And I think that's definitely called entrepreneurship. That's called investing, that's called all these things. And anybody who, you know, when you ask them like, oh, how's it going? If they're always like, great, you're probably not that close to them. Yeah, exactly. And if you're ever learning from somebody and everything is always amazing in their life, they're either lying or they're completely out of the game.

I agree.

Out of the game.

Now you've got different issues, but.

Exactly. They might be bored and they might have some wisdom to apply, but how current it is, I would definitely question.

That said, I want to talk today. We just did an episode on Summer Slowdown or just how do you generally deal with cyclicality in your business and what are some of the specific strategies and tactics for dealing with that? The kind of similarly related topic I think is how much cash should you hold in reserve or how much should you have as reserve, even if it's not cash, but like truly as a reserve to weather the bad times and the unanticipated. And, and there's a lot of different thinking on how to come up with that. And I specifically was asked by one of our portfolio companies to help establish that because they're doing, they're doing really, really well and they're going to have, you know, an eight figure profit up from a six figure profit a year ago. So it's a, like a big, big jump. And so, you know, everybody, all the owners and, and stakeholders are like, all right, you know, how about, how about you throw some of that out to, you know, for the boys, you know.

A little bit of, a little bit.

Of, a little bit of, you know.

Jingle in the jangle.

Yeah, yeah, yeah. And, and so the CEO asked me, said, you know, hey, I'm all for that. Typically we've done this, but things are just in a whole different strata right now. So, so how do we go about doing that? And, and so I wanted to chat a little bit about it and kind of brainstorm with you on it. What, what, what do you think are some of the best things to think about? So let's just kind of highlight some of the strategies that people do use and then let's talk about what we like about them and what we don't. The first one is to keep three to six months of operating expenses. I think that's typically a personal financial advisor recommendation as well. You should have six months of expenses saved as cash just in case something happens. And I think that's a good one. But then you also get to, in a relative dollars or euros or pounds kind of mentality, if it's a lot and you aren't Apple or Warren Buffett, can you afford to have that? Like if you're running at $3 million a month of expenses, do you need to have $20 million in cash sitting around? I don't know. You know, let's, let's, let's think about that. What are your thoughts on that as a strategy?

I think that at a bare minimum, every business should maintain at least one month of operating in an operating account.

Beyond that, just straight cash. You should have it there. Yeah.

And that is in your standard operating account where money kind of goes in and out of just so that you don't get in a situation where, you know, you bounce a check or something like that. Right. I mean, I'll give you a great.

Thing that used to hit us when we first, you know, started doing stuff together and we didn't have a professional accounting team, is that there are some months when there are three payrolls. Right. And those months absolutely suck because it's like, well, wait a minute, that's an extra 200,000 that I got to pay out this month that, that I, that I'm not thinking about. So just even for something as simple as that or the other thing that hits us very frequently is there's a holiday and so we're prepaying the payroll four or five days ahead of when we would have normally and we have to pull the payroll out of cash flow a few days before that to get it in the right account to be able to make the payroll. And so we may lose a week to eight days of, of, you know, of float, if you will. So I think just having a month is absolutely critical because there's stuff like that that happens all the time, right?

Yeah. Now more than a month in your operating account, that's when I think that can get a little bit, can actually get a little bit dangerous because it can make entrepreneurs start to feel fat and happy. Some will take their foot off the gas, some will over invest in things without doing it. So I like about a month in operating now outside of that, I do think it's important to have some type of a rainy day fund, emergency fund that, that type of savings. And I do think that in the aggregate, all companies should seek to have three months of operating expenses. And I would mean that like true operating expense so you can take out your variable. Like so this is if everything just you could Take out a lot of your variable expenses. So, you know, so I mean like fixed, your fixed operating. So your payroll, your rent, your stuff that you're going to have to pay, that's contractual. That's just absolutely the right thing to do. If everything goes horribly wrong, if you lose your merchant account, you can't do whatever. Well, you could turn off ads, right? You can turn off ad spend. So maybe we don't worry as much about that. But your fixed operating expenses, I think you need to have at least, I think one month of just general operating sitting in the bank account. And then in addition to that, let's have another two months so that in the aggregate, we're talking about three months of operating expenses. One month in an operating account, another two months in a separate savings account, but still cash or cash equivalent. So it could be money market, but I would keep that cash or cash equivalent. Now I've heard, let's try to get up to six months. I've known companies that were, oh yeah, we've got a year's worth of cash. Most of those businesses though were funded. They took some kind of funding.

Harder when you're bootstrapped.

Yeah, really hard. It's hard to build up to it when you're bootstrapped. And I would argue again, at some point, like you want to deploy this capital, like why is it just sitting there? And I'm a big fan and I know you, you taught me this because I was ultra conservative in terms of like, let's build up really large cash reserves. The downside to that is, number one, the roi, like the return, if you think about it from just a purely a capital allocation perspective, is kind of whatever you're getting in that money market account, which now at least is something, but it's still not much compared to what your business should be returning. I think the bigger issue though is again, when most entrepreneurs see a lot of cash, they go into one of two modes. They either take their foot off the gas and stop trying to grow as much or, and the most likely one, they over invest in stupid stuff. They say, oh yeah, of course we can make that higher. Of course we can sign up for that larger office space. Of course we can buy that big piece of equipment that I think we might need in a couple of years for cash.

But none of that has ever happened to us.

Well, only 100% of all of those has happened to us. And so yeah, I'm a big believer in anything over than that. About three months. If you're a bootstrapped company. Distribute it. Distribute it. And what I like about that now is if everybody agrees. No, no, no. This is absolutely something that we should do. Great. Write a check back into the company with all this money you just received. Yeah, because the, the other problem with keeping a ton of money in cash reserves is the business is like, let's say you're, you're set up as an llc. If that's going to hold there, that, that business is going to be taxed on that. So building up cash reserves to a large amount, you know, it is, is still, I mean that all that cash is good, you know, all that tax is going to flow through or it's going to be taxed at the company level, depending on your structure. So I'm a big fan of getting it out.

Yeah, I like it. Paying it out as well after that. And I agree with you on the, on the month plus two. To me, it's. Necessity is the mother of invention and that if you've, if you're sitting on a lot of cash, as you said, you can take your foot off the gas. And that translates into a lack of innovation, a lack of scrappiness that really can drive a business to have significant breakthroughs and get to the next level. The other thing I like about it, and we've experienced it, is if you're writing a check back into the company, you're kind of pissed. Like, I'm dipping into my funds to fund the company. And you could say, well, that's because I paid it all out. But it still feels like, what the heck are we going to do to make some stuff happen so I don't have to do this?

You're either, you're excited about the new investment opportunity. Right. And like, that's the ultimate, like that's the ultimate litmus test. Am I excited to put it back in? And if somebody says, look, I don't want to do it, I don't believe in as much. Great. It's going to alter the cap table. So it just keeps everybody so honest when you distribute it out.

Okay, so. So some other things. So that's the, the kind of, the months of operating expenses strategy. A couple of others would be the current ratio. So this is where you look at what are the current assets that you've got and divide that by your current liability. So current assets and current liabilities are typically those that are going to be cash or cash, like in 30, 60, 90 days and different, you know, they're different schools of thought on that. But basically, the things that are coming due. So let's say that you've got a million in current assets and you've got 500k in current liabilities, then your current ratio would be 2 because a million divided by 500 is 2. If you have a 1.5 to 2 current ratio, that's generally considered good. So a measure of how you're doing with your reserves. Kind of look at the three month thing that Ryan and I talked about and also look at this. And if you think about it, this is to keep you from becoming insolvent. This is so that you have enough to be sure that you can pay your debts as they're coming due. And if you think about it, it's, it's really like whatever cycle we're using for current. This is kind of cool to think about. How do these things relate. Whatever cycle you're using, if it's 30, 60 or 90 days to define what current assets and current liabilities are. If you go for a two, it's saying basically I want to have enough assets to cover two months of expenses. Right. Two months of liabilities. So that's kind of a cool additional like number one to tie those things together. And, and also as maybe a checker balance on. Do I have the right number? Is 3 the right number or 2 plus 1 plus 2, which is what? That's the new one we're going to say we invented one plus two. Right?

Nobody, nobody before now?

Yeah, nobody's thought of that before. Then a version of that would be. Another version of that would be a quick ratio. And the quick ratio you're taking out inventory because maybe your inventory cycle like your number of times or turns of inventory per year is high and you're turning your inventory every 30 days. Well then your inventory is definitely a current asset that can help pay current liabilities because it's going to transmogrify from. And this asset that is nothing to profit. Not only will you get the cost of your inventory because you're typically carrying it at cost on your, on your balance sheet, not only will that cost come back and be converted to cash, but it will actually be a multiple because hopefully you're at least keystoning or doubling the inventory cost when you sell it. So it's going to turn into a multiple of what it is right now. So, so if we take that inventory out, because let's say you've got longer cycles, maybe you only turn your inventory four times a year and it's a 90 day turn or you only turn it twice a year and it's a six month turn. Well then it's not really a current asset to be considered. And so we call this an acid ratio. It's basically the current assets minus inventory divided by current liabilities and you typically want to have a one for that. So that's another way. Any thoughts on that Ryan, before I hop into a couple more, the only.

Other piece that applies I think going back to the so no other thoughts on the current. I do like the way that they interplay with one another and I'm glad that you mentioned the quick ratio because certainly inventory intensive businesses, it's going to be a little bit different. One of the things that we found though when we had more inventory intensive businesses. Yeah if you're turning it every single month it kind of just starts to look like another operating expense. Like we buy it and it's gone and it's here and it has an roi sort of like advertising the only piece and if you're going to get to this later I'll defer it is having the need for some type of a sinking fund or saving for planned future expenses over and above the two months. So I, we can talk about that now or we can defer it. If you were planning on talking, go ahead. So going back to the, to the one, the one plus two, the one month in operating plus two in savings. The only amendment I would make to that is if you know that there's going to be a significant expense or investment on the horizon and this could be anything from we know that we're going to need to purchase a major piece of equipment and it's going to be X amount or the down payment that we need to put forward, you know, is, is Y then that is something that you would want to save for in a separate account because that is not just savings. So the one month that sits in operating that's just float to keep you going.

It's too much. Right. That three months of that one plus two or three that's that's hey just in case stuff goes wrong and we need that that's to plan for that. The other is a certainty, right. We're planning for a certainty that we know is going to happen because we know we're going to have to put a new roof on our building. We know we're going to have to replace that machine. Right.

We know we've got a $2 million budget event going out there, you know, on the horizon that we're going to need to save for. We know that we, we believe that we might want to make an investment, an acquisition. And we believe that we're going to need to have this much sitting around in cash either to put forth in the acquisition or to help with the integration of this acquisition. We know that we're going to be shifting our sales plan to go from purely an inbound model to, to more of an outbound fuel field sales model. And doing that is going to require us to hire an entirely new team that we don't have today. So we want to save for that. So strategic savings. And this is why it's so important and why I'm a big fan of, of everything over and above that. Once you've fully funded your operating account, once you've fully funded your rainy day, you know, emergency fund, distributing out everything over and above that, with the exception of wait, no team, wait stakeholders. We need to save for this big expense. And here's why. That keeps everybody honest and it ensures that when you do save, you're saving for a purpose. Not just saving to build up some more chests that you can just spend indiscriminately.

Yeah, exactly. So I think that's a good. That would be basically the contingency fund, which is the, the stuff that we've been talking about. Then separately we will want to have a reserve for certain things that, you know, are going to be costs that are coming up. So one thing that I think I'd say probably most of the businesses that we work with when we come in are shy on is cash flow forecasting. And so we've talked about, typically the financial statements most businesses have are a balance sheet and a P and L or an income statement, which. So basically the balance sheet is the list of assets, liabilities and shareholders equity. The P and L or the income statement is expenses, liabilities and profit, excuse me, is revenue, expenses and profit. And the one that very often gets overlooked is the statement of cash flows, which depending on your accounting method, whether you're tax accrual or, or cash based that you're looking at, it can be different. So if you're looking at a statement that isn't tracking actual cash flows, it's really hard to think about will we have enough to do what we need to do. So let's, let's chat a little bit about that. What's your experience with that and how do you think about that with the businesses that you're primarily managing?

I think for businesses that are in, you know, early stage growth and rapid scale and those can be two very different things. So early stage growth, you know, you're kind of zero to a million, $2 million where you don't have big nest eggs built up. But also businesses, when they make the strategic decision of, okay, we are now going to scale, we're pedaling the metal in those seasons. The statement of cash flows, I think is a far more valuable financial document than the balance sheet or the P and L. I mean, I'm not saying don't look at the other ones, but if you're going to say, like, I can only look at one of them, let me look at the statement of cash flows. Because at the end, you know, it is very possible to have a paper profit business on profit. You know, on paper we are profitable according to the P and L. But to go out of business because you run out of cash, right? I have seen plenty of quote unquote profitable businesses go out of business because they ran out of cash. To my knowledge. I've never seen a quote unquote unprofitable business go out of business that had plenty of cash flow. Not immediately. You eventually do have to fix that pesky profit thing. But as long as you have cash, you have fuel to continue to fight. And so I just, it is the most overlooked and I believe the most important. And if you don't believe this, just ask yourself, how did you do accounting when you first started your business? Probably the way that you did accounting is you just looked at your bank account and you said, okay, this time last month, you know, was there more or less?

Am I overdrawn?

That is a rudimentary statement of cash flow, right? That's kind of what that, that's basically what you're doing. So a statement of cash flow is simply a more sophisticated financial tool. That is the one that most entrepreneurs are most familiar with anyway. So I would demand it of your financial professional, whoever accounting financial, demanded of them that they provide that.

I love it. The next thing that will help kind of indicate how healthy your company is is the cash conversion cycle. And so this is a formula that basically tells you how short is the time that it takes us to turn the assets of the company into cash flow. And so I'm going to read the formula so I don't screw it up. But basically it's, you look at the, the days, the cash conversion version cycle is the days that your inventory is outstanding. And I want to read the explanations so I don't screw it up for you, but the day's inventory outstanding. So this is basically dividing the average inventory that you've got by your cost of goods sold and multiplying by the number of days. So this is our inventory is outstanding. How long do we have our inventory? Right, and then you're going to add to that the days that your sales are outstanding. And this is basically how long does it take you to turn your accounts receivable into cash? So you multiply your accounts receivable by the number of days outstanding and then divide by the total sales that you've got on credit. So cash sales you're getting paid for now, so that's good for cash flow. But some portion of sales is typically done on accounts receivable basis and therefore it's outstanding for some period of time. So the shorter that time is, the happier we are. And then we're going to subtract the days you're payable or outstanding, which is basically the accounts payable that you've got times the number of days it's outstanding divided by your cost of goods sold. And all we're really looking for there is a short cash conversion cycle. So basically, if you've got a day's inventory outstanding of 70 days and the days that your sales are outstanding is 30, you're going to add those together and then you're going to. Which would be 100. You're going to subtract the days your payables are outstanding, which let's say is 45. And then that would give you a cash conversion cycle of 55 days. So that's basically every 55 days you're turning those assets into cash. You would rather it be shorter than that. But again, tying back to the other things that we were talking about earlier, because a lot of times people are like, I don't know, there's 10 different things I should use. Well, they're actually all very related and it makes sense to look at them. So if your cash conversion cycle is 55 days, then it makes sense that you're going to have at least two months of reserves to cover the time that it takes to convert the assets that you've got into actual cash. Which goes back to our two plus one, goes back to our current ratio of two, back to our acid ratio of one. Right. All of them are interrelating and there are different ways for us to look at what's going on. But now if you found that like if we say general rule of thumb two plus one, but your cash conversion cycle is 180 days, then you might actually need to have six months of.

Cash or a line of credit. Yeah. Or a heck of a line of credit. I mean, I think that's an important aspect and that is the kind of thing if you're interested in getting a line of credit from a bank, which is harder to do now, having some of these ratios to take to them and to say, look, here's how much we have on deposit with your bank. So, you know, we're pretty good there. The reason we need a line of credit is because we need to close the gap between these, these two areas. That's what bankers need to see. Right? And entrepreneurs typically don't have these. They want to try to tell a banker a story like they're talking to an investor, VC or an angel. Bankers need these kind of ratios. I also like that, that, that particular ratio that you talked about because more, I've seen more and more businesses, us included, to maintain sales volume, we've had to increase the installment period like payment.

Plans, which is a form of receivables.

Fast forward back 18 to 24 months ago and everybody was happy to pay in full. Even the request for installment payments and payment plans and those kinds of things was fairly low. And the number of people who took us up on them was even lower. And so it was, you know, everybody was flush with cash. They were happy to do it, to save a little bit. That has completely inverted in terms of the number of sales that we get pay in full versus the number of sales who want installments. So while at the same sales numbers in the past you felt like you were crushing it, now today you feel like you're struggling and you don't know why and you're blaming inflation. Oftentimes it's more of a cash flow issue. So running that, running that ratio and realizing, holy crap, we're at 88 days, that's why, what can we do to pull some of this forward might be a problem solving.

I remember even when we had, when we changed a product type, this was five or five or eight years ago, maybe even longer, but we changed the product type from a, from a one time payment of, I think it was 3,000 to a monthly payment of $500. And because of the change in product, our cash conversion cycle basically 6x right? Because it was 6 months of $500 to get to the 3000 that we were getting before we gave up the 2500 cash that we would have gotten in exchange for a stream of cash flow of 500amonth which we hoped would exceed the 3,000. But even if it had, and we found, you know, sometimes it Didn't. Sometimes it didn't. But even if everything was perfectly as we assumed it would be, we forgot, hey, we're losing five months of cash flow.

Yeah.

Right off the bat. But our expenses didn't change and it almost killed us. Right.

And that's where, going back to what we talked about before with the, with those, those additional funds. So sometimes you need to set aside some money to make a major investment. Sometimes you need to set aside money to test a major new initiative. And so to say, hey, we're going to be doing this, this is the impact that we believe it's going to make from a cash flow perspective. This is what we're going to go backwards in terms of cash. It's okay, we've set aside X amount so that we can, we can fund this. And we would expect by the six month mark we're no longer having to fund into it. Now we've got a surplus. Now everybody's happy. We can distribute out the rest. Right. That is the more professional way of doing that. And frankly, not green lighting some of these tests until you know that you can sustain a failure or in some cases stay a win, you know, which.

Goes back to cash planning. Right. That's, that's why it's so important to be thinking about this, to have your, your idea, to have a clear picture of what your cash flow actually is. And then you think about the strategic initiatives that you've got and then how will they impact cash flow? Great question to ask. And then now the sixth strategy is a contingency fund which we kind of touched on for certainties, the contingency fund based on risk assessments and anticipated cash needs. So there are risks. We just set aside $3 million in one of our other businesses as a reserve for special situation that we had with a vendor that we had paid that didn't perform. And so that created a potential risk exposure of we determined $3 million. And so we actually had to put that money aside as a contingency fund in case things went poorly. Now we'll know in about six months what percentage of that will have to be used. I'm very, very certain it won't be all 3 million, but it could very easily be 700,000 to 1 million 500 and that, you know, like that, that's another thing. Do you want to take the, your decision there is do I pay all that profit out? And now potentially I'm called on to write a check, let's say that you're a single shareholder to write a check for 700,000 to a million, you know, into the company. Well, now you personally need a contingency fund, right? So, so I like that. Now there are contingency fund formulas based on percentages of revenue. I feel like that's one of the worst, least in connection with the company kinds of ways you can do it. If you are going to do that, then I think you go back to what's the profit margin that I've got? And your profit margin against your expected or historical profit margin against your projected 100. You know, close to certain revenue will give you an idea of the profit, profit or cash that you'll have to work with. And then you're looking at what's the cash cycle to get the profit. To me it gets too complicated. So I like a contingency fund for we know this is going to happen, we're testing this initiative and we're certain it's going to change things. But hopefully in the long run it will be better. And we're long run people, so that's okay. But how do we stay in business and pay the bills in the meantime? We forgot to think about that way back when. And that was painful. I remember that really, really well.

It was terrifying. And it's one thing to be panick when you lose because something goes, goes poorly. You don't want to be put in the situation where you're panicking because the thing that you wanted to happen happened but you didn't prepare for some of the second order consequences of that. And that was exactly the situation we were in. The pivot from one off to MRR and subscription was the right decision long term. It created more value, created more revenue long term. We just were not prepared for it from a cash flow perspective. Big mistake, big lesson learned. Hopefully people don't make that one.

At least learn from us, not from you. The next thing is kind of a supplement. I don't think it's a replacement, but it's a supplement and that's a line of credit which you touched on earlier as well. Your business, if it doesn't have one, should have a line of credit not just for whatever you've got it for now, but also for contingencies. So a line of credit is a really, really great resource for allowing you to distribute money out to yourself or invest money in the company that will receive a significantly higher return than the cost of the money that you'll have to pay on the line of credit. So if you can get a line of credit at 6 to 10% and in your company, you're operating at a, you know, at a 50 profit. Well then you're getting a 5x on the money that you reinvest in your company over and above the. Well, if it was 10, you're getting a 5x because you're getting 50 and maybe you're getting 50 on multiple terms. So maybe you're getting 50 and you're turning your, your cash flow four times a year. Right. You know, now you start to really think about that's, that's significantly more same thing in your personal life. Now if you're taking your money, you're going to distribute it out and put it in a 3% fund, then the 6% that you're going to pay interest to a bank on a line of credit is double what your costs. It's double the cost of capital that you're getting on return. You should take that money and put it back in the company. But you should for sure. Those are all finance decisions. But in terms of a contingency optionality play, having this line of credit that you can draw on that should be at least equal to the reserve that you think you need. Let's say that you have a two plus one reserve and so you've effectively got, let's just call it three, three months of expenses that you've got reserve that you're holding in the company. Now you go get a line of credit for that three months as well. You've effectively doubled your carry time and now you've got three plus three or two plus one plus three. Right. That gives you a lot of flexibility. Now you can draw on your internal cash reserves. You can say, I don't know, I want to keep that just in case. Let's tap the line for this downturn we've got right now. And you're covered. Right. So a line of credit, like how much line of credit do I need? Can tie into the, or at least as a minimum can tie into all those other things that we're saying so that all these things harmonize and come together. Thoughts?

You're dead on. Couldn't agree more. And I think that's how you, because people talk about three to six months. I think the way that you get to six months, it's not just having cash, it's having access to cash is kind of the same. And so I don't love having six months just sitting there. It's, it can make you feel warm and fuzzy. But talked about it before. Cause you take the throat off the gas. Cause you to make Stupid investments that you shouldn't be making. So how do we mitigate against that? You go two plus one and then in addition to that to kind of close the gap between the three and the six month. Yeah. See if you can get you a line of credit. Most banks, if you can show that you've got X amount on deposit, they will give you an equivalent amount in a line of credit. Once you have some reputation with the bank, they won't even require you to necessarily guarantee that much. But if they do, that's not, you know, that's not the worst thing in the world to still go out there and get that line of credit. I will simply say, when you get it, use it. We've made the mistake in the past of not using our line of credit because we didn't need it. And then we lost it. The bank came in Revalu, like, ah, we noticed last year you only used $50,000 in your line of credit. So we're dropping it to 50 grand. Those lines of credit sit on the bank's balance sheet as a liability. Okay. So they sit on their balance sheet as a liability. And if they're not making any money off of that because you're not using it, then they will absolutely pull that back. So every now and then you can.

The other thing that was.

Pull it back down.

Yeah, absolutely. The other thing that we experienced, which was absurd and so be careful of this, is the line of credit that's not really a line of credit. So if they require, if they give you a million dollar line of credit but require you to have a million dollars deposited with them, then they're really not giving you a line of credit. They're just loaning your money that's 100% secured with them back to you at an interest rate that is far above the interest rate that you're going to earn on the money. What we did in that case was we said, screw that, we're canceling the account and we'll just do our own line of credit there. Right. So your line of credit needs to be a true line of credit, not a secured line of credit that you have money that now you can't access. Because if you thought that if you put three months of expenses in the bank and got them to give you a line of credit, but it was secured by a covenant that you had to keep that money in the bank, then you don't really have that money in the bank because you, you either take the bank's money and then draw on your money and you're out of covenant and they call their loan due and payable immediately, or you spend the money and you're out of covenant immediately before you did the line of credit. And the line of credit reduces correspondingly to the amount of money that you took out of the bank and you still don't have anything. So be careful not to fall in that trap. And in one of those scenarios, our actual, our accountant was recommending we do that. And we're just like, this makes no sense.

Yeah, we're, we're paying three times what.

We'Re getting on this money. Let's just do it ourselves. It's, it's not a real line of credit, which should.

And I think if you have a windfall, then that does make. So when you go from three months to six months or maybe even longer, if you have a significant windfall, that, that's a, that's a decent use of, of proceeds is to say, let's, let's essentially be our own bank, you know, for this, for this business. I don't think that's a bad thing. All at scale. All businesses become banks. All businesses. And executive leadership at a company becomes about capital allocation. So I think making the decision to do it when you have a windfall makes tons of sense. We actually had one bank, I don't know if you remember this, they said, yeah, we'll give you a million dollar line of credit if you buy a million dollar cd. And so it wasn't just have it on deposit with covenant, it was actually lock it up into a certificate of deposit. Why would we do that? It had to be one for one. If, if that's what you're hearing, either you're just, you're just a little too early and that's okay, or you've got the wrong bank and it might be time to shop around. Before you move, though, go to them and say, here's our balance sheet, here's our P and L, here's what we currently have on deposit. What could you do for us from, you know, we'd like to get a line of credit for this amount. What, you know, what can you do? Because they also had lineup in addition to that. Not only do we have to have a cd, but they also wanted personal guarantees from all of us. It's like, wait, so you're gonna loan me back my money and still make me sign a personal guarantee?

Absurd. But they will, they'll frequently ask and you can always say no, and then you'll find out how important that personal guarantee is. But they're pretty much always going to ask for. For sure.

Yeah, for sure. And you know, depending on the life stage of the business, how much you have, it may be what you need to do. We as a general try to never ever, ever, ever sign personal guarantees. And yet there have been times when it was appropriate. And so we did. So I don't want anybody to come off saying it's something you should always do or something you should never do.

It's, it's amazing. So the next thing that I want to talk about is the eighth one would be scenario planning and stress testing. This is something that is one of my favorite things to do is to create a financial model for your business and your cash flow. And that's as simple as an Excel spreadsheet or as complicated as pivot tables and a bunch of other things. But what you really are looking to do here is say what happens in if then scenarios? If we move from a $3,000 sale product to a $500 sale product, what happens to cash flow if we lose this customer? What happens to cash flow if this acquisition takes us away, our focus away from the business and causes us to earn 50% less for the next six months? How does that, you know, how do we, what if, if we buy this company and our expenses go up or if we take a line of credit and we've got a service of debt, if we buy that, you know, all of that, if we buy a building it just like that is so important. And it goes with cash forecasting. But this is different because it's scenario planning, right? It's, it's stress testing the business when, when bad or good things happen that are going to impact cash flow. How do we end up having that model I think is really, really helpful. Another thing to do is benchmark. So in your industry, there are other people that are in your industry and they have operating expenses and reserves and all of those things. And we like this from a kind of just checking, how are you doing against the rest of the world is my pay. Like, you might have a general rule that Payroll should be 20% of revenue, but maybe in your industry payroll is 30% of revenue. So you could beat yourself up because yours is 20 or 22 and really still be significantly ahead of the pack. If you're not looking at benchmarking now, that doesn't mean that you look at them and go, oh, I'm okay, I don't need to look at mine. But it's good to look and you can do the same Thing with reserves. So look at data that's provided by companies like BVR and other, you know, McKinsey and Bain and all those guys will typically have reports. Your industry or your industry association will also typically have this data. Look at what are the benchmarks for the industry with respect to the different key components of your business and the ratios and percentages of them. You could do that for some of the things that we said. You could do it for reserves, for quick ratio, for acid ratio, for, you know, all of these kinds of things. Cash conversion cycle. These would all be things that you can look and see with the industry. What are my days Inventories outstanding. What are my days Accounts receivable are outstanding. What's my cost of gold, cost of goods sold percentage to the rest of the things that I've got. And that will help you see that you are at least in line. And if you're not, then you can figure out what can I do specifically to get there.

Can I give everybody a free tool that'll help with that? Yeah, yeah. If you go to Scalable co. So Scalable Dot co Tools. One of the, one of the free tools that we offer is the expense ratio Analyzer. And it will actually allow you make it really, really simple for you to plot in what should it be. So what are your benchmarks? And then you go put in your actuals and it'll tell you, okay, where are you over, where are you under? And make, you know, give. Give specific recommendations on what should be, you know, increase and decrease. Really simple tool to give you a very, very quick snapshot of, you know, where are we overspending, maybe where are we underspending? But what I like about the Expense ratio analyzer is one of the lines in there is profit, right? So you're required to put in how much profit do you want to put in there? So it really does start with this kind of profits first mindset. Again, scalable co tools. Scroll down to the expense ratio Analyze Analyzer. Can download that totally for free.

I love it. And then the last thing is just to be regularly. The 10th is just to be regularly looking at your cash flow and analyzing. Like just be sure that you are on a schedule for this, certainly at least quarterly. You should be taking a look at this. And then you can kind of, maybe you should. You want to look at it more. Or if you find quarterly is. Is. Is too frequent, you might go to six months. But I do think it's really important. And so I'd like to wrap up and I think because of the time that we've gone on this, Ryan, let's divide this into two podcasts. We'll do five and five, since we've got 10 strategies. So just to wrap up, you know what the strategies are now, how do you actually build your cash flow? Like, like how do you create that? Well, the first thing is you have to look at what is our current cash flow. You have to assess, you have to be aware. So going through the exercise of seeing where is cash flow right now? Do I actually have a statement of cash flows and what does my cash flow conversion, my cash conversion cycle look like right now? Then use any of the 10 things that we talked about or a combination of that we've been talking about to actually establish and set a reserve target. This is the target that we want to get. Now. I wouldn't recommend that you immediately say, I'm going to pay myself nothing until I hit that target. I would say what is a reasonable strategy for me to get to that target? Maybe you need to have a million dollars. Do I recommend that you would take a million dollars out instantly? No. Maybe you can take out a hundred thousand a month for 10 months.

Right.

Or, you know, or maybe you even need longer because you can't. You, you live off of every bit of that million dollars that the business is making right now. Then you might need to make some adjustments, but you want to get there as quickly as you can reasonably get there without adversely impacting your own financial situation. And I'd love to get your thoughts on that before we go to the next step.

Right, yeah. What we've done is say until you can build up a, that, that one month operating, basically, yeah. Starve to death. I mean, only pay. You only take out the absolute minimum that you need to live. That is the time frankly to be lean because you don't have a lot of options once you've built up that kind of one month operating expense fund, everything over and above that, we divide it 50, 50. So 50% gets distributed out to the extent that it is free. The other 50% gets added into the savings to get up to the additional two months. So that's kind of how we've done it. Now, I should add, all of this is after pulling out money first into the tax account. So whatever you owe in taxes, that comes out first because the government has missiles and you don't, they can literally take your business, they can take your liberty. So all the things that we're talking about come out after the government gets, gets their share but yeah, we've Simply done a 50, 50. If you want to accelerate it, you could do, you know, a 70, 30. If you need a little bit more, you could change it. But I like going 50, 50 until you get the two months operating expense.

And 5050 is what, just to be.

Clear so of the distributable amount. So everything over and above you, you get to the end of the month or whatever, you look and you say, okay, great, this is how much we need to have in our operating expense. Maybe say it's $100,000. Every dollar over and above that amount is available for distribution. That is your distributable amount. You want to take 50% of that and put it into the savings to begin to build that up. And I would go ahead and take the 50% out as a distribution. Unless you need to save for some other planned contingency for some other planned investment. I would go and take it because I do believe you need to develop a practice of distribution early on.

Okay, I love it. So step one is assess your current cash flow. Step two is set your reserve target. Step three is automate savings. So whatever that formula is that you've decided, or maybe step three should be pick the formula, but to me it's kind of part of it. But you need to get that going. And you don't want, you want it to be automatic. You don't want to be thinking about it. So whatever you need to do to set up automated transfers, even if you have to look at it every month and say, okay, it's 50, 50 and, and the amount changes, you can give your CFO or if you are your CFO, you can give yourself the instruction or you can give the bank the instruction. This is what's going to go. And maybe it's to set a minimum and then you can adjust and cap off the minimum. If you have excess but like some base amount, get it in there so that you're building the reserve, then you want to invest the excess. So if you get past that cash amount and even if you've got cash, that cash could be in a money market because money market is as good as cash to tap, right? And you should be earning at least currently about 5, 6% in your money market. That's important. Don't just have the money sitting there doing nothing. Have the money actually earning you money. And then the last step would be to monitor this and be sure that you have the right reserve and that you are doing this on a regular basis so that you can adjust it, which is the six. The actual. Excuse me, fifth step, adjusts that the reserve based on the reality of your business. So that takes you through 10 strategies to set the reserve and five strategies to get your your cash reserves established, automated and actually earning you money. I hope you guys found that helpful. Ryan, anything to say in closing?

I would just, I would say the ultimate sign of a healthy, valuable, exitable business is not revenue. It's not NPS score. The ultimate sign of a healthy, valuable business is that company's ability to distribute large amounts of cash to its stakeholders on a quarterly or even better monthly basis. That is the ultimate sign of a healthy business. And so to develop a practice of good cash flow management, to develop a practice of distributions is, I think, incredibly important. You should do it earlier than most people think. Do not, do not, do not fall for the line that banks and investors want to feed to entrepreneurs that you need to wait until the end of the sale to get paid. That is complete horse crap. Of course they tell you that they are incentivized to tell you that they want to keep what they perceive as their money in the business so they can get it when they want it. Certainly if you're bootstrapped, develop a practice of distributions. Not only will it make you happier, it will be the ultimate sign that you're running, you're, you're, you're efficiently running your company. I love it.

Well, hope you guys have found this helpful. We are going to divide this into 2, 2, 5 strategy, I think sessions because we went a little bit longer than we want to do. But it's a really important topic and I think it can be really helpful, particularly as we experience downturns in the economy that we talked about in our episode before this. So hope you guys enjoyed it. If you did, please share it. Let us know if you have any thoughts. If you got other strategies, tactics, techniques, experiences, war stories, horror stories, great stories, please share them with us. We definitely want to hear them. And we'll see you next time on Business Lunch. Awesome. My computer mouse thing has frozen, so it's going to continue to record and my button to stop the recording doesn't seem to be working. So I'll let them do it. Yeah. Froze. That's really weird. Anyway, I'll tell them that it stopped about 50, 54ish minutes. But that was really great. I thought. I think that's really valuable for people.

I agree. I'm trying to see if I can stop the recording from my end. I can't.

I'll text the my tech team. Cool. That's great though.

Yeah, no, that was a really good. Are you gonna record like a little thing at one point or is somebody going to record a little, you know, hey, this episode went long, so join us in the next one kind of thing.

Yeah, I'll do it. I'll do it now. Let's do it right now, real quick. Okay, recording. Please come up. Okay. Hey everybody. This is going to be a two part business lunch. Ryan and I are talking about how you can establish a reserve for your company so that you've got contingency funds available in the event that good or bad things happen. And we talk about 10 different strategies. We're going to cover five in the first episode and five in the second. And we're also going to give you five. So that's 10 total strategies for setting the reserve amount and then we're going to give you five, a five step strategy for actually setting that amount. So look forward to having you there and that's what this is going to be. Hope you enjoy it and we'll see you there. Okay, so that's the first one and then I'll say. So that's it for the first half of the strategies of these two parts of this two part episode on how you can create a reserve. And, and what are some of the strategies for doing that the next five will do in the next episode. Ever wondered how some people build real wealth through acquisitions while others just sit on the sidelines? Well, I'm here to tell you it's not about luck. It's about having the right system, the right deals and the right guidance. And that's exactly what we give you in the EPIC Deal Fast track. If you've been thinking about buying a business, but you keep getting stuck, whether it's finding the right deal, structuring the financing, or negotiating with sellers, you are not alone. Too many people waste months, even years just thinking about acquiring a business while the real opportunities pass them by. The EPIC Deal Fast track is not another course. It's actually an implementation program. And it's designed to get you from the idea to the acquisition in just 16 weeks or less. We work with you one on one to help you find, fund and close your first or next deal. And once you do, we're going to plug you into our elite EPIC board community so that you can keep scaling through acquisitions. We install three powerful systems in your business. The first is the Deal flow engine. So you always have high quality off market deals coming to you. Number two, we give you our offer and funding system so that you can structure offers that get accepted and fund them creatively many times with no money out of your own pocket. And number three our closing and integration system so that you don't just buy a business, you actually successfully run and scale it once you have acquired it. Plus you'll have direct one on one support from an epic deal advisor every step of the way and that's people that have actually come up through this system and done these deals themselves. That's the only way to become an epic deal advisor. And if you're serious about acquiring a business this year don't just sit on the sidelines. Just text I'm in to 334-45-89034 and we'll get you in. So text I'm in to 334-45-8034 we'll get you in. No fluff, no wasted time, just real deal making from people that are actually out there doing deals right now. I'll see you there.