When your business is thriving, it can seem counter-intuitive to set aside cash when it could be used to grow your venture.
But what will you do when you hit a downturn?
How can you be sure to survive it and prosper, as well as hold on to key staff?
Setting aside a fixed proportion of revenue each month will help weather any downturn and means you’ll automatically save more when times are good.
So, when a downturn comes, you can survive, or pivot your business model, without suffering terminal cash flow problems or laying off key employees.
Here I look at five ways to create a fund and how it could benefit you.
1. Store away a fixed percentage of profits before re-investing:
Work out what proportion you need to put away in good times in order to survive the bad and stick to it. As for the size of your reserve and its required longevity, that will depend on your circumstances. Talk to your advisors.
Remember, your startup will live and die by its cash flow. According to the Chartered Institute of Management Accountants,
Effective cash flow forecasting is essential for monitoring net cash flow so that periods of negative net cash flow (when payments exceed receipts) can be covered by operating capital.
Three months’ minimum
So, you’ll need to run a cash flow forecast to see how much your startup might bleed during a downturn. That will determine the size of the fund needed, from an absolute minimum of three months’ reserve up to 12 months. And this will establish roughly what percentage of revenue you need to put aside for your startup’s unique circumstances.
How can this help your startup?
The bigger the reserve, the greater your ability to survive protracted periods of negative net cash flow, retain key staff or address the need to pivot suddenly if your business model’s no longer viable in a fast-changing market.
Don’t be a slave to fixed sums
Putting aside a fixed percentage of profits each month before re-investing in growth will help you save more in high-revenue months. And you won’t become a slave to a fixed sum each month when you find yourself in the middle of a downturn.
2. Establish a good cash-flow system and pre-allocate profits:
With a “sales minus profit equals expenses” approach, you can pre-allocate profit and build reserves.
Parkinson’s Law has been around since the 1950s and is based on the principle that demand tends to expand to meet supply.
But when applied to budgeting, it means we’ll spend as much as we have available.
But if you pre-allocate profits within a robust cash flow system, you’ll only spend what’s available after profit is put aside.
What you can’t afford isn’t spent
So, if you have less of it – in other words, after you’ve deducted your profit – not only will you spend less, you’ll become more careful with cash and more creative in the pursuit of revenue.
Slaying the cash-eating monster
In his book Profit First, entrepreneur Mike Michalowicz turns on its head the accepted formula to profit that “sales minus expenses equals profit”. He argues that this “old” formula creates a cash-eating monster of a business. Instead, he encourages a “sales minus profit equals expenses” approach.
How can this help your startup?
In short, if you’re strict about the allocation, you won’t spend what you can’t afford.
Break up revenue into pre-determined allocations
Break up incoming revenue. You can pre-allocate profits as a proportion of revenue before it’s even come in, with the remainder covering strictly controlled operating expenses. And with profit pre-allocated, it will be easier to build your reserve through those fixed-percentage contributions.
3. Reinvest your cash reserve in corporate savings plans:
It’s worth seeking advice as to the best type of plan, but in the UAE, index-tracking funds or dimensional investing funds are worth considering.
Making your cash reserve work for your startup
Both offer low fees and high returns, with the latter relying on the principle of achieving the greatest return for the risk taken – or conversely, minimising the risk in a given portfolio targeted to achieve a specific return – by combining asset classes in the portfolio to achieve effective global diversification, thus minimising downturns in any single asset class.
How can this help your startup?
Funds you set aside could be earning money rather than sitting in a bank doing nothing. For the last decade, interest rates in the UAE have languished just above the one per cent mark, with rates only recently beginning to creep up.
But if invested correctly, corporate savings plans could deliver excess returns which can either grow your reserve or go to investing in long-term benefits for employees, thus helping with the UAE’s often problematic retention issues.
4. Consider a corporate credit card:
Although generally not a good idea to take out high-cost debt to fund long-term borrowing, an extra credit facility can be useful in certain circumstances, especially emergencies.
How can this help your startup?
Using credit facilities to invest in equipment or services vital for your startup’s continued success can often make more sense than dipping into your reserves or diverting contributions to the fund.
Why?
Because the debt can be serviced through the extra revenues generated by that investment.
This leaves your reserve intact and earning interest in a corporate savings plan ready for that inevitable rainy day.
5. Build recurring revenue streams:
Whether through hard contracts or retainers from clients, recurring revenue is attractive because it’s predictable.
How can this help your startup?
In short, it introduces greater levels of certainty.
It not only guarantees that you’ll be able to put cash aside for that rainy day if you follow point #2 above, but also makes it easier to secure a corporate credit card.
Because even though a corporate card is unsecured debt, it nevertheless gives the bank reassurance that you’ll have the wherewithal to service that debt if needed.
Save more in boom times
It may sound obvious, but if you opt for a fixed percentage to put aside each month, rather than a fixed sum, you’ll automatically be building your reserve in a way that amasses most when you can most afford it, protecting you from those inevitable downturns.
Setting up your own business has never been easier. Virtuzone takes care of it all so you can focus on what matters – building your business. For more information about company formation in the UAE mainland or free zones, please call us on +971 4 457 8200, send an email to info@virtuzone.com, or click here.
