Establish a “rainy day account” separate from a bank line of credit or bank loan. It is much better for you to be your own banker. If you want to pay interest, pay it to yourself. You’ll want to establish an interest-bearing account at a bank or a money market fund. There are several contractors who have established stock mutual funds for their rainy day accounts. In my opinion, these are too risky for dollars that you think you will need at some point within a year.
There are two easy ways to invest in your own rainy day account. The first is to write a check to this account for 1% of all deposits that come to the door. This takes discipline. You can’t wait until the end of the month to do it. You’ve got to do it every day or at least once a week. The key is to make the amounts small. You won’t miss 1% of revenues. And the deposits add up over a period of time.
The second easy way to set up the account is to put your residential service agreement revenues in the account. For commercial accounts, put the estimated profit from commercial contracts into the account. Technically, when a customer pays you up front for work that you haven’t performed, you have a liability and should put the cash in a separate account until the work is performed. Many contractors don’t do this and mix the service agreement funds with the regular operating funds. However, by telling your bookkeeper to write the checks for the service agreement amounts to a separate fund, you will quickly build up a cash reserve.
You may have times where you need the service agreement dollars to fund operations. That’s OK. However, in the busy times of the year when you are cash rich, you definitely need the money from service agreement sales to fund operations. This is the time to put the dollars in a separate account.
How big can the cash reserve be? One of my former customers wanted to retire from the business in 10 years. To fund their exit strategy, they decided not to touch any of the service agreement dollars they took in the door. Over several years, it amounted to hundreds of thousands of dollars which is earning interest and being invested today. They don’t have to worry about where the cash is going to come from for their retirement.
The key to both of these techniques is to have the discipline for regular savings deposits. It is actually a job for your bookkeeper. You’ll be surprised at how quickly the dollars add up. And the money is there to fund emergencies or slower times of the year when you need cash to pay bills or make payroll. I’ve also had contractors use these funds to purchase assets. In my opinion, it’s better than borrowing on a bank line of credit for operating capital or a bank loan to pay for an asset.
Copyright 2001, Ruth King. All rights reserved.
Ruth King’s American Contractor Exchange
1650 Oakbrook Drive, Suite 405
Norcross, GA 30093