How big should a company's rainy day fund be?


6

"They" have always said that, as an individual, we should have enough in cash savings to cover 3-6 months of living expenses.

Have you heard of a rule of thumb for (small) businesses? How do you decide what a month's expenses are (because, theoretically, you can easily cut payroll - but not rent and loan payments)?

Finance

asked Oct 13 '09 at 12:32
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Alex Papadimoulis
5,901 points

3 Answers


5

At SEOmoz, we're currently keeping between 3-4 months of full expenses in the bank (a higher multiple for purely operational expenses). I think that's a bit low, but I can say that many of the VCs we talked to felt that our bank reserves were quite conservative for a tech startup and actually worried about why we hadn't been more aggressive with spend if we felt there was dramatic growth opportunity. It's definitely a hard battle to wage.

My general feeling is that the amount should be based on the size and maturity of the company - at the very beginning, when it's largely just an idea in development, reserves are pretty smart. They give you time to iterate in case the first launch doesn't bring in the cash you need. In high growth stages, you might want to be somewhat aggressive - if you're profitable, it might actually be smart to stave off profitability by investing back into the business. Once you reach a mass of several non-founding employees who rely on this paycheck, you might want to again lower that risk profile so you don't end up cutting staff if a few months are slow. It's definitely a philosophy thing though - I'd guess there are dozens of smart, successful founders with very different perspectives on this.

answered Oct 14 '09 at 03:25
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Randfish
1,001 points

1

Cashflow management is a key skill for an entrepreneur. Go get a copy of the book "Financial Intelligence for Entrepreneurs" by Karen Berman & Joe Knight. Yesterday. Lock yourself in a room until you finish this book.

No, I don't have any affiliation with this book. It's just the best one I've seen that deals with finances in the startup/entrepreneur realm.

answered Oct 14 '09 at 03:27
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Dalenkruse
599 points

1

I would say it should be based on a combination of previous and projected cash flow of the company which are also dependent on your receivables.

If receivables were not a concern then I would go 8 months plus for a rainy day fund. Keeping in mind that this is just an emergency fund and not an expansion fund.

answered Oct 13 '09 at 12:37
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Anup
547 points

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