Entrepreneur’s have a highly contagious, optimistic outlook on their business, product or idea. But too many lose respect for the probability of failure and the fact that the odds of success are stacked against them.
Only 35% of new businesses in the United States make it past the five year mark and it is estimated that fewer than 4% achieve the one million dollar revenue threshold. The entrepreneurs that are fortunate enough to succeed, must think differently in order to keep their newfound wealth.
Russell Holcombe, CEO of Holcombe Financial points out bad things happen to good people all the time.
Bad things can also happen to entrepreneurs more often because of the additional challenges of business. Employees steal money, salespeople depart taking a big account, and business partners get divorced.
As Holcombe says “predicting a financial catastrophe is impossible; everyone would avoid it if they knew it was coming. Survival is dependent on access to resources and unfortunately banks only lend money when nobody needs it. Access to capital is the only thing that buys time and the best source of capital during a crisis is cash.”.
Holcombe asks small business leaders to think of liquidity like an airport runway. “The longer the runway, the more room for error exists. Jets taking off from an aircraft carrier only have one chance to get it right. Liquidity lengthens the runway. In my experience, it takes three to five years to regain bearings after a financial catastrophe.”
Holecombe recommends entrepreneurs must have two lines of defense against catastrophe – business liquidity and personal liquidity.
“Business owners must be able to cover both business overhead and their family’s lifestyle to be in the safest position. To find out if an asset is liquid, ask yourself the following question: “Can I turn it into cash in 24 hours or less?” If the answer is yes, liquid assets are ready to be deployed to help remedy the situation. If the answer is no, assets are worthless in event of financial trauma,” he adds.
Holcombe cites Greg Crabtree’s book Simple Numbers, Straight Talk, Big Profits! For the dictum he believes — every business should have two months of expenses in cash. He calls this Core Capital.
But as Holcombe says “unfortunately, cash is an after-tax asset. When success happens, people hate paying tax and CPAs enable clients to make bad decisions by showing them to how to buy new equipment they don’t really need or funding retirement plans. Retirement plans are useless to a 40 year old entrepreneur with a cash flow problem in the business. Don’t protect the business from trauma; everything else does not matter.”
According to Holcombe, the next line of defense is personal liquidity.
In his book, You Should Only Have to Get Rich Once, he discusses the Cash Flow Stress Test. “Your lifestyle cash flow is the after-tax money per year the family requires to survive. The Safety Net is the amount of assets that are available to pay the family bills if all income stopped tomorrow, he adds.
The components of this test are:
- Stocks, bonds and cash in after-tax investment accounts count toward the Safety Net but houses, college savings plans, and retirement plans don’t.
- Divide the Safety Net by the Lifestyle Cash Flow to arrive at the number of years the family could survive on after-tax resources without adjusting lifestyle.
- You pass the Cash Flow Stress Test if you have 3+ years of liquidity.
As a final dictum, Holcombe urges small business leaders “to fight the urge to save tax until you build up your after-tax liquidity both in business and personal life. It is the difference between people that survive financial hardships and those that don’t. “