Last weekend I paddled my first winter trip on Puget Sound in Washington State. It was 38 degrees air temperature and 48 degrees water temperature. The steam was rising off the water. I started out too hot and almost took off my rain coat. Will suggested I wait just a bit until we rounded the point where it is often a bit breezier. He was right.
In any cold-weather sport, whether it is skiing, snowboarding or kayaking, dressing in layers is critical both to comfort and to safety. It is the same in business when it comes to liquidity. Here are your layers:
1) Breathing layer…closest to the skin:
Adequate working capital
Working capital is defined as current assets (assets that are cash or will turn into cash within the year) minus current liabilities (liabilities due within the year). Current assets includes savings accounts so having adequate ’emergency’ savings is in this layer. Accounts receivable and inventory are also in this category.
Lenders often look at this in a ratio, called the ‘Current Ratio’. 1:1 is too low unless you leave inventory out. 2:1 is often considered the guideline although it depends on the type of business you are in.
2) Warmth layer…in-between:
Short-term credit lines and business credit cards
This is access to quick additional cash. A commercial seasonal line of credit gives you access to cash on a short-term basis. A business credit card fits the bill as well. This should be short-term, though. If you need funds for a longer-term need, like purchase of equipment, look for a term loan instead.
3) Weather layer…outside to keep you dry:
Personal liquidity (savings and excess income from other sources)
If the unexpected comes up, your business is short of cash and you do not have quick and easy access to business credit, your personal liquidity is the back-up. If yours is a small to mid-size business, the business lender not only will require a personal guarantee, but will take a look at your personal cashflow and liquidity to determine if your guarantee is really helpful as a potential source of repayment.
In kayaking in cold waters, you have to dress for the water temperature. You don’t plan to go for a swim in 48 degree waters but you just might have to. Layers allows us to be comfortable…and be ready. Just like in business.