Monday, October 4, 2010


In my head are various cash positions that characterize the health of my business. There is a distinct feeling of dread or elation whenever we transition to a new condition. Check them out and see if they correspond with your personal finances or the finances of your own business. We'll use the Defcon scale, considering this a cash defense condition. Nobody ever talks about this in business, it's too personal, but it's on everyones mind.

Defcon 5: Very healthy. All of my invoices are up to date, paid in cash and there's a healthy cash reserve in the bank. How much of a cash reserve? How about 3 months of operating costs. Honestly, coming out of a big expansion, this tends to happen only during the holidays or Summer months. Stores at Defcon 5 have opportunities that others do not, such as the ability to buy out failed businesses that hit Defcon 1, or taking advantage of sales on both merchandise and supplies. They can maneuver quickly and they have a reserve to fall back on when things go bad.

Defcon 4: Healthy, at risk. All invoices are up to date, paid in cash, and there's a small cash reserve. Credit is available, if there's a problem, but it will be expensive or will at least have some additional cost. Unfortunately, this is where I operate most of the time. A small cash reserve can be measured in how many days until we're out of money. During good months, it might be weeks. When it's only measured in days, Defcon 3 is around the corner.

Defcon 3: At risk. My invoices are never intentionally late, but if money is very tight, or I'm intentionally tweaking cash flow, I might fall back on bank credit to cover expenses, always paying them off in full. This is a bad place to be because it often adds additional costs to the business. There is no cash reserve at Defcon 3, which limits opportunities and increases risk of failure if something bad happens. This is my worst operating condition to date, yet orders arrive, payroll is met (including my salary), and the store continues to do fine. Always paying my salary regardless means I'm rarely in the incredibly stressful position of having both the business and my personal finances in crisis simultaneously. That leads to the crazy.

Defcon 2: Failing. Everything is being deferred or put on bank credit. Some might start borrowing money from themselves or friends at this point. There is no operating cash. Credit cards and loan payments are only getting minimum payments, instead of paying them off  in full every month (as we normally do). Something will need to improve soon or the end is near. This is circling the drain. A lot of business that I read about trying to apply for special SBA loans during the worst of the recession seemed to be in this boat. They're probably gone now.

Defcon 1: Death Spiral. Credit card payments are late or credit has been cut off. Sales are being used to cover operating costs, with orders not being placed at all, or infrequently. The shelves are looking bare. Suppliers are only accepting COD, as you've burned your credit. You're personally out of money and your friends you've borrowed from are annoyed with you. Perhaps you're job hunting or have hired a clerk to run the store while you re-focus your life. Eventually the quality inventory will be exhausted and the sales of the dreck will no longer cover expenses. Does the landlord chain the door at a certain point? I've only heard rumors. I know of a couple stores right now in this position. It's the dreaded inventory death spiral.

My point in writing this is to encourage you to keep these conditions in mind, or create your own scale. The minute you cross a line, you can begin planning how to improve your position. Sometimes you can wait it out, especially when you know a big sales season is approaching. Still, many businesses have just been unlucky and that ship never arrives. Other times you may need to ask for help. Ideally you have planned ahead and have cash and credit to fall back on. In the worst case scenario, you should have an exit strategy.

I recall having a very concerned discussion with a business partner during the recession, when everything was doom and gloom. The conversation started with the question: "What does failure look like?" If you don't know what it looks like, how will you know when to quit? Will you go down with the ship? Being able to recognize Defcon 1 was what I came up with.

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