When my nephew was eighteen, he wanted to buy a new car on credit. I counseled him to buy a car he could afford for cash and begin saving what would have been his monthly payment for the next six years. If he wanted a new car then, he would have the cash to buy it and could begin the savings plan anew. He got someone else to co-sign.
The point of the story is he did listen; he just didn’t have the discipline to save, a fault many businesses suffer. Very few business plans include setting aside savings equal to depreciation costs, sinking funds for equipment replacement or modernization, or self-insured retentions. All funds which will be needed at unpredictable times.
Self-insured retentions include deductibles on property claims, retentions under umbrella policies, uninsured claims, or even disagreements over valuations. Realize these situations will occur over time and preparing for them is important. It’s a good bet that every business will have fluctuations in good and bad markets over a twenty or thirty year period of time. The worst problems invariably occur during down cycles, usually because corners are being cut on a regular basis.
Start your sinking fund discipline by reviewing your insurance policies and internal procedures to determine how much cash could potentially be required to respond to emergent situations: collision damage to a car, window replacement in buildings, or any other minor but usual event. Put this amount aside or create a plan to save it immediately.
Next, consider normal long-term issues like property fires, depreciation, or equipment upgrades due to modernization. Begin buying Certificates of Deposit or other cash equivalent interest bearing investment. You want low risk and liquid to respond to these types of issues. You can buy CDs on an annual basis and have some mature each calendar quarter to get a bit better returns.
Once the quick cash reserve is in place, you can begin investing these deposits in longer-term higher-yield investments like stocks or mutual funds. The important step is to begin a program of savings for the unexpected. This advice is some of the best risk management: be prepared for the disaster, and it won’t be a financial disaster.
