Why don't businesses have emergency funds?

[disneysteve]

My daughter asked this morning why so many businesses seem to have no savings for emergencies? Why is being closed for a month or two enough to put them out of business? If I lost my income for a couple of months, we'd be just fine because we have sufficient savings. Why isn't the same true for many businesses?

I explained a bit that businesses often use their profits to expand and reinvest in the business, open new locations, etc. They also pay out some of that money to their investors.

But is there more to it than that? Is there any fundamental reason why so many businesses seemingly operate right on the edge, paycheck to paycheck essentially? Is that just an American phenomenon or do businesses in other countries do the same?

[bjl584]

Apple aside I think most publicly traded companies are under pressure to invest their cash into R&D, debt paydown, or expanding.
I assume that the investors want a return on their capital that a cash hoard doesn't yield.

[disneysteve]

Apple aside I think most publicly traded companies are under pressure to invest their cash into R&D, debt paydown, or expanding.
I assume that the investors want a return on their capital that a cash hoard doesn't yield.

But don't investors also want businesses to be financially stable and have the ability to endure challenges and market downturns?

I realize that what's happening right now is truly unprecedented but even under normal conditions there are various things that impact a business whether it's bad weather, natural disasters, or just changes in the marketplace. Shouldn't every business owner have a little something set aside for the unexpected? Maybe they do and we just don't see it but it seems like I'm seeing so more stories beginning to pop up of places that have announced they won't be reopening after the COVID shut down. If being closed for 2 months was enough to put you out of business for good, you must not have had stable finances to begin with.

[rennigade]

Just another reason why im glad im not self employed. Apparently, there's very little money to be made in owning a business. The only explanation I can think of, is businesses operate on the brink of destruction each and every month, which we're seeing. The owners only mission is to recover all of their costs, build the business up, then eventually sell it. It seems like very little money is made up until the point the owner sells. What a strange business to be in.

[james.hendrickson]

Perhaps its obvious, but not all businesses are all the same. Some are high margin, some are low margin. The financial viability of a business also depends a great deal on the skill and financial management ability of the leadership of that business.

[bjl584]

But don't investors also want businesses to be financially stable and have the ability to endure challenges and market downturns?

I realize that what's happening right now is truly unprecedented but even under normal conditions there are various things that impact a business whether it's bad weather, natural disasters, or just changes in the marketplace. Shouldn't every business owner have a little something set aside for the unexpected? Maybe they do and we just don't see it but it seems like I'm seeing so more stories beginning to pop up of places that have announced they won't be reopening after the COVID shut down. If being closed for 2 months was enough to put you out of business for good, you must not have had stable finances to begin with.

Ideally, they would have some cash for emergencies.
But, I guess just like the average person, they are living on the edge.

Small struggling businesses are probably the least equipped to save money. Money comes in and it goes right back out. Rinse and repeat. Except when you can't repeat and you go under.

[Scallywag]

CMG & ISRG have minimal debt. FB & GOOG have healthy balance sheets. It's untrue that you need debt to grow.

[disneysteve]

CMG & ISRG have minimal debt. FB & GOOG have healthy balance sheets. It's untrue that you need debt to grow.

Definitely. Just ask Dave Ramsey.

[disneysteve]

Small struggling businesses are probably the least equipped to save money. Money comes in and it goes right back out. Rinse and repeat. Except when you can't repeat and you go under.

I guess, but that leads right into rennigade's reply:

Apparently, there's very little money to be made in owning a business. The only explanation I can think of, is businesses operate on the brink of destruction each and every month, which we're seeing. The owners only mission is to recover all of their costs, build the business up, then eventually sell it. It seems like very little money is made up until the point the owner sells. What a strange business to be in.

This does seem to be the case. Unless the business really takes off and becomes a wild success, there often doesn't appear to be any great profit. I know of numerous businesses where the owner takes very little income for himself and may have other friends or family members who work there for free or close to it. I can understand that when you're just starting out trying to get the place off the ground, but once you've been at it for a few months, if there isn't a good amount of money rolling in every month, why keep doing it?

[kork13]

In business, I think it's rare to have more than 2-3 months of operating expenses held in cash, for many of the reasons already mentioned. There really isn't anything fundamental besides that. You mention Dave Ramsey running his business without debt.... But he's even acknowledged on his show that whole he does set money aside for savings in the business, he's said that he's never gotten it above 3 months, because there are always new, more profitable ways to use that cash.

[disneysteve]

In business, I think it's rare to have more than 2-3 months of operating expenses held in cash, for many of the reasons already mentioned. There really isn't anything fundamental besides that. You mention Dave Ramsey running his business without debt.... But he's even acknowledged on his show that whole he does set money aside for savings in the business, he's said that he's never gotten it above 3 months, because there are always new, more profitable ways to use that cash.

Maybe that's the answer. Entrepreneurs, pretty much by definition, are not conservative people. They are risk takers. They can't stand sitting on a pile of cash. They just keep thinking of what they could be doing with that money, how they could be putting it to work to make even more money, damn the consequences. If something unexpected happens, they'll just take out a new credit line or charge stuff to their American Express business card.

I guess that's why I'll never be a business owner. I couldn't function like that.

[Singuy]

You are suppose to run with a good idea and expand asap using leverage due to risk of competition. Once your good idea is out and you have a successful business, expect many "me too" businesses that wants to steal your marketshare. Or even bigger corporations would want to take your market share if you don't spend your R&D correctly. Sometimes no matter what you do, your business is doomed no matter what because the gigantic corporation just has too much brand power. A good example of this is Fitbit vs Apple. An example of a company defending their products successfully would be DJI vs Gopro.

Allocating capital is perhaps the biggest challenge when running a business. I do not agree with Dave Ramsey at all because the way he run things is just too conservative. Who the heck pays off a house first before buying a second rental? Having 20% down and enough emergency fund to weather 6 months of no tenants is probably all you need. Now don't go crazy and start putting 5% down and buying the town. That's crazy as well.

[corn18]

Ask TexasHusker. He has no EF and rolls all capital back into his businesses for growth. How's he doing now?

[disneysteve]

Ask TexasHusker. He has no EF and rolls all capital back into his businesses for growth. How's he doing now?

Yes, that's a perfect example. He owns multiple vacation rental homes which have all been sitting vacant for a couple of months. He also owns 3 hair salons that have been closed due to COVID (though salons were allowed to reopen yesterday so hopefully he's back in business). He had posted at one point having already spent 70K out of savings due to the shut down, so he had money set aside to allow him to do that, but what about all the business owners who didn't have that kind of reserve?

[~bs]

My daughter asked this morning why so many businesses seem to have no savings for emergencies? Why is being closed for a month or two enough to put them out of business? If I lost my income for a couple of months, we'd be just fine because we have sufficient savings. Why isn't the same true for many businesses?

I explained a bit that businesses often use their profits to expand and reinvest in the business, open new locations, etc. They also pay out some of that money to their investors.

But is there more to it than that? Is there any fundamental reason why so many businesses seemingly operate right on the edge, paycheck to paycheck essentially? Is that just an American phenomenon or do businesses in other countries do the same?

I'm assuming she's referring to small business.

And the reason is the small business is connected to the owner's personal finances, and the profit represents their income. The owner has their own personal expenses and savings to contend with. So when a business faces trouble, the owner needs to immediately dip into their pockets because the business finances represents their own. And depending on the financial success/stability of the owner, the business may or may not be able to survive a protracted downturn.

For example, I have a small sole proprietorship business. Any income (pretty much) passes through directly to my pockets. Any losses directly hits my wallet. Do you think I'm going to take hit after hit of losses if I can walk away from it? The fact that I have additional financial resources and ability to borrow money doesn't mean that a smart choice to make, especially in such a severe downturn that's WORSE than other recession because youre not going from 100% income to 90, then to 80. You're pretty much hitting full brakes and going to 0. If you're a restaurant or other business and you have the opportunity to walk away from that situation quick, only a fool wouldn't do so.