Money-Smart Solopreneur. Laura D. Adams

in this chapter can help you balance your day job with your side business, but only you can decide when it’s time to leave your job. In the next chapter, we’ll cover how to ease the added financial pressures of becoming a solopreneur so your transition is as smooth as possible.

       CHAPTER 4

       CREATING YOUR SAFETY NET

      Career changes can be challenging enough without added financial pressures. Becoming a parttime or full-time solopreneur may require you to rethink your personal finances.

      While some entrepreneurs might encourage you just to quit your day job and start working from a beach or while traveling the globe, that’s not a successful strategy for most. The more you can shore up your finances ahead of a career move, the more options you’ll have for building your business.

      Even if you have steady income from a day job, you may have substantial expenses getting your venture off the ground. You may also have clients who turn around invoices more slowly than you’d like. You may bill with net 30 terms—which means payment is due on or before the 30th calendar day (including weekends and holidays) of receiving your goods or services—but clients may take much longer than that to pay.

      You may also have seasonal opportunities that cause your business revenue to fluctuate. For instance, a swimming pool cleaning service may have less business during the winter months in many states. To avoid scraping by during the off-season or when clients are late paying you, you need to build a foolproof financial foundation.

      A big part of creating healthy business and personal finances is building strong safety nets that protect you and help reduce stress. Life and money are both unpredictable. Just as a smart acrobat would never cross a high wire without a balancing stick and a big, strong net stretched out below, you should never go without a financial safety net.

      In this chapter, we’ll cover the importance of having a cash reserve and offer realistic tips on how to build one as quickly as possible. I’ll review ways to make thoughtful cuts to your expenses and debts, including ratios to use as guidelines for your numbers. Use the strategies and formulas in this chapter to take a deliberate approach to managing your money so you have plenty of options and are never backed into a corner, financially speaking, as you build and grow your solo business.

Build a Cash Reserve

      If you don’t have any savings, take advantage of your day job’s steady paycheck to build a cash reserve now. Without money in the bank, it can be challenging to be creative or feel justified spending time on your business.

      Having as much financial resilience as possible will allow you to leave your day job sooner or increase investments in your business. Consider the worst-case scenario: You believe your side gig is profitable enough to quit your day job, but for whatever reason, your revenue then quickly dries up. The importance of having enough financial cushion to support you during your business’s ups and downs can’t be overstated.

      I recommend that you maintain a minimum amount of extra cash in the bank. Whether you call it emergency savings, an emergency fund, a financial freedom fund, a safety net fund, or a cash reserve, the idea is that we all need extra money set aside for the unexpected.

      A cash reserve keeps you safe and prevents you from going into debt during a rough financial patch in your personal or business life. If you don’t have savings, a sudden large expense or drop in income might take you years or decades to recover from.

      Not having enough money on hand to pay for an emergency is how many people get into credit card debt. If you make card charges that you can’t afford to pay off quickly, interest on the balance grows every month, and you could end up owing two to three times the amount you initially charged.

      So do what you can to make sure you’re prepared for the unexpected. Having enough money on hand for emergencies is never a luxury. Building up a reserve should be one of your top financial priorities as you plan and build your business.

      Not only does having a safety net protect your finances, but it also gives you incredible peace of mind and eliminates stress. You’ll feel empowered knowing that you’ll never be trapped in a job because you can’t afford to leave it. And having a cash reserve becomes even more critical if you plan to quit your day job and rely entirely on your business income.

      How Much Cash Do You Need?

      You might be wondering exactly how much emergency money you need to protect yourself. While no one can predict the future, I recommend having enough to cover your living expenses for at least three months. By that I mean just the basics—housing, utilities, groceries, insurance, and loan payments—and not a full replacement of your income.

      But having a six-month or more cash reserve is even better. Replacing your job income or managing a downturn in your business could certainly take at least six months, depending on your industry. It’s a good idea to periodically evaluate your needs and adjust your emergency fund goal as your life, business, and employment situation changes.

      One way to decide whether you have a sufficient emergency fund is to calculate your cash reserve ratio, which tells you how long your cash would last if your income dried up. This ratio equals your total cash on hand divided by your monthly living expenses:

      Cash Reserve Ratio = Cash on Hand / Monthly Living Expenses

      Let’s say you typically spend $3,000 per month on essential living expenses. If you have $6,000 in liquid emergency savings, then your cash reserve ratio is $6,000 divided by $3,000, or 2. So you’d have two months of financial leeway in this example.

      As I mentioned above, a good rule of thumb is to have a cash ratio of at least three. In other words, make sure you could survive with no income for a minimum of three months. But if you have a large family, high debt payments, or work in an unstable industry, you might need a 12-month cash reserve. Look at your financial situation and consider how long you could stay afloat if you lost your job or business income today.

      Where Should You Keep a Cash Reserve?

      The purpose of having a cash reserve is to keep it safe and risk-free so that you’ll have it for emergencies and planned short-term purchases. Since you don’t know whether you’ll need it next week, next year, or in three years, I recommend that you keep it in an FDIC-insured bank savings account.

      A common question I get from Money Girl podcast listeners is whether you should invest your emergency money. Unless you have an unusually large amount of emergency savings, such as more than a year’s worth of living expenses, the answer is an emphatic “no.”

      Even though people tend to use the terms saving and investing interchangeably, they’re not the same thing at all. The difference has to do with risk. There’s always a tradeoff between financial risk and return. Investing your money means you could enjoy relatively high returns, but you could also risk losing some or all of it.

      With FDIC-insured bank savings, you won’t earn much interest in return, but you won’t risk losing it either, regardless of what happens in the financial markets. Even though a savings account pays a low interest rate that may not even keep up with the inflation rate, that’s OK. Remember, the purpose of your cash reserve isn’t to make money, but to save you from potential financial hardship.

      Make a goal always to have enough money saved to protect yourself in an emergency. If you invest it and expose it to market volatility, it could vanish when you desperately need it.

      How to Build a Cash Reserve Automatically

      If you haven’t started saving emergency money yet, the prospect can seem daunting. Don’t worry; just get started by taking small steps every month. Make a plan to accumulate $100, then $500, and then $1,000, as quickly as you can.

      Depending