Do you save money in your business to avoid the problem of raising working capital? Other entrepreneurs in Kenya make the mistake of saving too much cash, and this comes back to bite them.
So what is the right amount of cash a small or medium-sized business in Kenya should save? When you’ve just started your business, the only savings you can speak of are the investments stipulated in your business plan to cover costs before you get to revenue and profit. You still need to read this.
An entrepreneur running an established business, on the other hand, needs a cash reserve to cover for periods of low cash inflow and for any surprises that may arise. Like a resistance movement boycotting your products.
A manufacturing business needs to save money to cover for fixed costs when business is low. If you are a trader, you’re always up against infinite short-term cash obligations, like giving out ‘change‘, so you have to save money. Even service businesses with their low expenses and higher profit margins must hold cash since they have fewer assets to sell-off should their businesses collapse. We don’t pray for this.
The first step
Lack of foresight is one of the 8 deadly mistakes entrepreneurs in Kenya make regarding working capital. It comes as no surprise, then, that a business saving the right amount of money is one that has drawn up a cash flow budget.
Saving too much money comes with its dangers. You may, as I do, feel that hoarding money can only be a great thing. After all, when you feel sad, you can always check the balance of your cash stash and feel better again.
But when your business holds too much money, you’re essentially betting against growth of your business. When your business starts getting more than enough cash on its hands as a result of either fast growth or reducing costs, you must put it to good use. When a business saves too much money, it is foregoing investment in producing more, marketing wider and deeper or investing in research for new opportunities. In fact, each time you save money in business you basically take away from the pool of money available for reinvestment into the business.
Ultimately, limiting growth of your business in this manner will catch up with you. This may happen through a competitor exploiting an opportunity you ignored, despite having finances to do so, or the overconfidence that creeps in to a business that is boosting its balance sheet reading by having a lot of money on hand.
How to calculate amount of money to save in business
Before I show you, I must prod into your personal life. Do you save money? It’s difficult to be a good financial manager if your personal finance is not in order. If not, bookmark our savings challenge as one of your resolutions for 2018.
As we said before, your savings are going to be determined by your cash flow budget. This will be determined by the kind of business you are. Are you an aggressive business that prefers to grow ahead of profit by prioritizing market capture and getting to economies of scale? Are you a business that has its feet on the ground and you prefer the slow growth of managing costs and perfecting the business model first? One day we’ll discuss which is better.
With the realization above, you’ll get a rough idea of your burn-rate. This is the amount of money you’re using as working capital. You need to keep it as tight as possible. An example is of, retailer, Walmart that reduced the size of its sales receipt.
Burn rate
To calculate your exact burn rate, you divide your working capital forecast (and any other monies you intend to use) by 12 months. You want the result to be low or, best, negative. Remember that any of your forecasts should always be conservative. Don’t ever assume business will be too good.
Knowing the burn rate is fine but knowing the exact amount of time your money will last is better. It is advised that the cash you hold as part of savings and in flow should last you a minimum of 2 years, when divided by the burn rate. Savings alone should be enough to last you between 3 to 6 months.
Continue reading: financial ratios every Kenyan entrepreneur should know