Leadership optimize

Cash reserves: the ideal and the real

Independent consultants, do you have cash reserves large enough to be able to do without any business for six months? If not, Chip Camden explains why it's prudent to set aside funds.

Running your own consulting business requires cash. Unlike employees -- whose initial cash outlay typically consists in transporting their bodies, reasonably clothed, to work the first day -- independent consultants usually have to provide their own equipment, workspace, software, business license, and a whole host of other expenses before they can collect their first dollar, euro, or yen. Additionally, we have to keep a certain amount of cash available at all times to meet recurring or unexpected expenses and to stay afloat through the famine phase of the feast or famine phenomenon.

Ideally, you should have cash reserves large enough to be able to do without any business for six months. That would allow you to develop exactly the kind of business you want, which would likely result in making more money in the long run. Why do the rich get richer? It's because they have the luxury of deciding how they will use their money. By contrast, most people have already committed most of their income and often all of their reserves, which severely limits their choices for new ventures.

Besides this fund for anticipating the unexpected opportunity or the inevitable rainy day, you should also put aside funds for known, recurring expenses that are too great to take in stride. For instance, in the USA, most independents must pay their taxes on a quarterly schedule. The tax bill for an entire quarter would probably break a monthly budget, so you need to prepare for that expense by saving a portion each month to avoid getting behind. Oh, if you do get behind, you'll find that the IRS will politely avoid mentioning it. They'll gladly assess penalties and interest after the fact that would make putting the balance on a credit card a (not much) better choice.

Another big ticket item is software licenses. I try to use free software for most things. I've found that a good open source community often produces a better product and provides better support than their high-priced, closed counterparts. But some clients insist on certain brands. In my business, for instance, I can't afford to ignore Microsoft. So the annual MSDN Subscription renewal is another expense I have to incorporate into my plan, however much it makes me grumble.

Regarding hardware purchases, it's not too hard to plan for upgrades. You can usually see those coming. But we often forget to plan for failures. We're fortunate to live in a time when the price of a disk drive makes it something you can afford to keep on your shelf, or replace just because it's getting a little old. If you wait for disaster to strike (and eventually it will), you'll spend a lot more time responding to the situation. Invariably, your time costs more when it's demanded unexpectedly. Not only do you waste more time because you didn't plan for the event, but you might miss other opportunities in the process.

So, all of you smart consultants have at least $100,000 in ready cash, right? In my 20 years as a consultant, I have never even come close to that. And with the economy doing what it's doing (or rather, not doing) I don't see myself getting to that ideal situation any time soon. I don't think I'm alone here. If you're in the same boat, then you have to sort out your priorities and develop a contingency plan.

The one thing you don't want to do is to immediately jump down the credit card hole. It takes a long time to climb back out. Worst of all, it costs more money. That's the problem you're trying to solve, not make worse. If you keep going down that path, pretty soon you're shelling out hundreds of dollars a month just for the privilege of having used that money in the past.

You can effectively use a credit card for smoothing cash flow, as long as you know that you will be able to pay it off soon. For example, if you need to travel on business, your client might take a month or so to reimburse you. You can charge those travel expenses, so long as you turn around and pay them when you do get reimbursed.

You can also use a credit card as a poor man's excuse for the Rainy Day fund. But be careful. Two or three unexpected hits in a row, and you could easily find your credit balance spiraling out of control.

With any loan on interest, you need to evaluate the total cost of that loan and compare it against the benefit you'll receive from those funds. Don't take out a business loan to grow your operations unless you can anticipate that the interest expense will be more than offset by increased revenue at some point. Otherwise, you're just blowing money on your hobby.

Even if you can't maintain it, it's still good to have an ideal cash situation in mind. That tells you what you need to do with the extra funds when you get paid for that big job. Don't blow it on a new car or an expensive vacation if your cash reserves are scraping bottom.


Chip Camden has been programming since 1978, and he's still not done. An independent consultant since 1991, Chip specializes in software development tools, languages, and migration to new technology. Besides writing for TechRepublic's IT Consultant b...

Tom Sullivan
Tom Sullivan like.author.displayName 1 Like

I have been consulting for 18 years and for most of that time have maintained at least 6 months worth of expenses in my company bank account. After my first consulting gig ended, it took about a month and a half to find the next one and I hadn't had the opportunity (or foresight) to build a reserve (besides, it was only a 4-month gig). We lived on credit cards during that period and ran up considerable debt. That's when I vowed never to let that happen again and have always maintained a reserve. The first couple of years we didn't go out to dinner or take vacations while we paid off the debt and built up the reserve, but it was worth it. The longest I've been between gigs since then was about 3 months. I won't say it was easy, but I was able to wait for the "right" opportunity rather than settling for something less out of desperation just to ring the cash register.


I have an opportunity to bring on an additional consultant to help out a client of mine, and suddenly realized that I'm going to need to be able to pay my consultant a couple of weeks before my client can pay me. So if you want your practice to be in a growth mode, you will want to set aside some funds for when opportunity strikes. I'll be paying my consultant via 1099, but if I want to consider W-2 employees, I'll need to have AT LEAST 3 MONTHS of anticipated revenues set aside.

ps2goat like.author.displayName 1 Like

Chip, As a newer consultant, I've never been able to justify the cost of the MSDN subscription. I have minimal requirements from the client, since we mostly only work in ASP.NET. If you are a freelancer, there are opportunities that come along. For example, small shops can sign up for the Website Spark program from Microsoft. The very first setup for this gave away free copies of Expression Studio-- from which I use Design and Blend the most. I believe all companies who sign up still get things like SQL Server 2010 and Windows Server 2008 web server edition. If you become Microsoft certified (which isn't hard), you have access to the MAPS subscription for < $500 per year (around $350 for the lower-end subs.). I can understand how you may want to use the subscription for access to all the older programming tools, though, if you need them. What else do you use your subscription for?

Sterling chip Camden
Sterling chip Camden

First, are the programming tools. Clients expect projects to be Visual Studio solutions. Second, operating systems: the software I write generally has to run on all recent flavors of Windows (right now, it's XP/2003 and up, but not too long ago it included Windows 98SE!). Finally, some of my clients do automation of Office applications from within their application, for things like mail merge.

HerbyDumling like.author.displayName like.author.displayName 2 Like

Some suggestions:- 1. Make your vehicle last an extra couple of years. When you buy your next car look for a secondhand quality motor and then look after it. My Volvo is now 10 years old and still looks okay. Depeciation cost less than ??1,500 per year. If I turned up at a prospect's site in a brand new BMW he would question every penny of labour costs. Remember you are in a service industry and so you are the servant. A servant does not have a better car than his master. 2. Pay off your mortgage as soon as you can. Knowing you have to find the mortage money each month without fail is a stress point. The 4-5% mortgage interest is far less than you would be paying on a bank loan so avoid the bank loan by invest in paying down your mortgage in the fruitful years. 3. If you are getting into problems then talk to your suppliers and bankers very early. Yes, they will be jumpy at first but most will work with you over the short and mid term. Ask for 90 days rolling credit and most will say yes even if reluctantly. If you get a bad payment record then no one will want to know you. 4. Pension - in the good years put as much surplus profits in to your pension pot. It usually avoids paying tax on your profits and so gives a good return. Then in the bad years you can miss paying into your pension without a worry. 5. Sell your second home. We had a customer who never paid his invoices on time and it was almost always a threat of Court action which got him to raise our priority. I then learned ha had a second home, with a big mortgage, which he was letting out. Just sell the second home and put the money into your livelihood. 6. Draw up a Domestic Budget. Get to know where you income goes and when. You will be able to know what you can make saving on and what can be cut all together. Having a grocery budget of say ??100 per week stops those 'too good to miss' bargins from going into your supermarket trolly. Having a domestic budget means you know just what you need to take out of the business each month to survive. 7. Avoid the Credit Cards. That is a very deep black hole and is best avoided. Set up a standing order to settle all credit cards on time each month. Yes, your bank account takes a hammering but you have fewer points of debt to manage. 8. Get a good life partner. My wife has helped me through many a cash strapped period. Having a friend to talk to also helps to put problems into perspective. She is always telling me to dump bad customers well before they good bankrupt on me. Should have listerned to her more. 9. We have a saying "If you want to make a million running a Fish & Chip shop then the best trick is to start with two million". If you are under capititalised you are going to spend too much time managing cash rather than your business. Start with more money than you need as it always costs a lot more than you had planned/hoped. If you don't have the capital just go and get a job until you built up an adequate reserve. 10. Don't panic. Economic cycles do have their up as well as their downs. Just hang in their add you will survive.

biancaluna like.author.displayName like.author.displayName 2 Like

I have 2 years worth of reserves, not really a really big issue now that I am temporarily gainfully employed but I want to go back to the independent life as I miss the flexibility. The other security I have is both income protection and trauma and life insurance. Chip, this is of course a good point for indies, but frankly, everyone should try to build up reserves. I was retrenched many years ago before I became an independent, although that hit me from left field, it also gave me an opportunity to really think about my financial practices, my financial education and my plans for the future. yes, there were some austere years, but you know, I still drive the 15 year old car and I pay myself first and my life is reasonably stress free from a financial perspective. It can be done, I found someone to help me map it out. I think your advice may need some expansion - educate yourself financially. I know this sounds pretty strange as we run our own business right? Then why have I seen several of my indie pals in dire straights when illness hit or a life event occurred they were not prepared for. Why do most people spend what they earn to the max? You are right, have a budget with those costs, set your overhead and that drives your rates. Include your insurances in there, we have some hefty liability insurances in Australia. Most of those expenses are (partly) tax deductable but you need to fork it out before you get it back. Leveraging and finding supplementary sources of income are also great tips, I do some paid work organising events for IT organisations for example. Diversity of service lines, right? Sometimes you must pay it forward to get it back, even some larger corporations don't get that. Most of what you are talking about is mindset and sometimes that means you are gonna have to challenge some beliefs you have. About money, about discipline, about austerity being a sacrifice, about that won't happen to me and about but I know it all and I can't do it right now. Great installment!

JohnMcGrew like.author.displayName like.author.displayName 2 Like

...the statistics for people "living paycheck to paycheck" were appalling. A single bump in the road was all it took for millions to instantly descend into disaster. Chip's suggestions should apply to everyone regardless of how they get paid. The only difference for consultants is the unequal increments in which we are paid and the additional kinds of expenses we must consider. The only suggestion I'd add would be to use some sort of financial software (Quicken, etc) and plot your known expenses out for at least a quarter ahead at a time. Insurance, mortgage, and quarterly tax payments should not be unexpected surprises. And flirting with debt plants you on the event horizon of a black hole if you don't have a viable plan to escape immediately. If when you're looking 6 months ahead and there's no money left for savings, it means you're already in trouble.

www.indigotea.com like.author.displayName 1 Like

One of the ways that I'm working on that in my own consultancy is branching out into different revenue streams. A balance of new work, maintenance contracts for existing clients, product add-ons that we can sell repeatedly, sponsored blogging...it helps to smooth out the bumps, and hopefully will let us start getting that bigger cushion into place. I'm also a big fan of leveraging partnerships like WebsiteSpark/BizSpark, which give you access to free licenses of various MS products.

gharlow like.author.displayName 1 Like

Unfortunately, 6 months of reserves in this economy is insufficient. Two years is a lot less risky.

Sterling chip Camden
Sterling chip Camden

The more cushion the better. I could only dream of having that kind of cash.

SKDTech like.author.displayName 1 Like

But I would have to live a spartan existence for a year to build it up. Of course, spending the better part of three years unemployed had my priorities on the straight and narrow when I became gainfully employed again.