How Much Dry Powder is Enough?

One of the most difficult things that I have ever done was to graduate from the US Army’s Ranger School. This school literally breaks you down and puts you in impossibly stressful situations to teach you how to lead when you have had little to no sleep, food, or comfort. One of the keys to leading when you are under stress is to have standing orders, so that everyone has common knowledge under which they operate. One of those standing orders was to always have your weapon ready to fight. This meant to keep it clean, operating and with enough bullets. This standing order goes back to Robert Rogers, who was the father of the US Rangers. Rogers told his men that they were to keep their musket clean as a whistle along with 60 rounds of ball and power. Unlike today, where the bullets that are used are self-contained with the metal bullet and the gunpowder, Rogers and his men had to load their weapons, first with gun powder and then with the bullet. Rogers’ Rangers used to keep their gunpowder in a waterproof pouch, because it was better to have no gunpowder than to have waterlogged gunpowder (at least they wouldn’t be carrying around the weight of the useless gunpowder).

So, what does this story have to do with entrepreneurs today? Dry gunpowder was the critical tool that allowed Rogers and his Rangers to do their job. Cash is the critical tool that allows entrepreneurs to do their job. Just like Rogers directed his men to always have a certain amount of dry powder on hand at all times, today’s entrepreneur needs to have a certain amount of dry powder on hand at all times.

If I were in your shoes, the next question that I would ask is “How much dry powder do I need to have”? My answer is that I don’t know.

Every entrepreneur and their business is unique, which means that the amount of cash reserves held by a 70-person government contracting firm would not be sufficient for a 30-person electronic manufacturing company. I want to give you a rule of thumb to provide a start; but then I will also provide you some questions that you need to ask yourself to determine if a higher reserve amount is necessary.

I believe that the minimum amount of cash that a business should have on hand at all times is the higher number of either 3 months of all in operating cost (to include all in debt service) or 10% of the total amount of debt held by the company.

For a quick example, lets assume a phone ap development company that has $2.5 million in revenues, generating an after-debt service profit of $300,000. Additionally, the company has $1.2 million in debt split between a real estate loan and 5 equipment loans.

The monthly operating expense (to include debt service) is $183,333 (($2,500,000 – $300,000) / 12). Therefore, the cost to operate this company for 3 months would be $550,000 ($183,333 x 3).

10% of the total business debt would be $120,000 ($1,200,000 /10)

In my opinion the minimum that the company should have in strategic reserves is $550,000.

I would be willing to bet that some entrepreneurs would look at this and say that amount of cash is unrealistic to keep in the company. It would be better used to purchase new equipment, buy a bigger building, increase the marketing plan to get more customers, pay off debt early, reward the owners for their hard work, or any number of other uses.

I understand exactly where they are coming from and I love the fact that entrepreneurs see cash and immediately think of ways that they can use it to make more cash. But remember, your dry powder allows you to withstand any major business changes (your main supplier goes out of business, inventory costs increase unexpectedly 25%, 3 of your biggest customers suddenly force you to accept net 90 day payment terms, there is a groundbreaking technology that just hit the market that will lead to the end of your industry). It buys you time to adjust and react to the unknown; it is not a R&D slush fund.

As we said earlier, every entrepreneur and business is unique, so here are some questions that you should ask yourself to determine if you need more reserve is needed:

• How much is needed in order for you to have a good night’s rest?
• How concentrated is your customer (or supplier) group? How would your company react if your best customer (supplier) went out of business?
• What is your working capital cycle and how easily can you influence it?
• Is the cost of your supplies fixed or open to fluctuation because it is a commodity? If it is a commodity, can you hedge your risk?
• How much debt do you have and what are the payment amounts and times?
• How seasonal are your revenues, expenses and debt payments?
• How vulnerable are you to regulatory oversight?
• Do you import or export any goods, which can be impacted by tariffs?
• Where are your customers?
• How much new equipment or machinery has to be replaced every year?
• How much money does your average competitor have? Having more dry powder may be a competitive advantage for you.

While this is not an exhaustive list, I hope that you can see the point that the operations of your company bear some risk and the amount of your dry powder reserve protects you against that risk. Let me also be clear, that I am not demanding that this reserve be kept in the name of the business. Many entrepreneurs that I know want to keep only enough cash for operational activities in the name of the business. They take out any excess cash each year in the form of dividends. You need to speak with your banker as to how your bank views this (and your CPA to understand potential tax ramifications). However, if the cash is taken out of the company, the entrepreneur needs to realize that the cash needs to be retained (i.e. you don’t go to Las Vegas and put it all on 1 roll of roulette) and that the cash may be need to be injected back into the company in the future. This can cause a physiological resistance and one that you need to be aware of.

Being an entrepreneur is one of the most difficult and demanding things you can do. The good news is that entrepreneurship today is a team sport. Hit the connect button on LinkedIn or Facebook NOW and together we will start maximizing your profit, strengthening your leadership skills, defining your strategic vision, and using your bank as a strategic advantage. When we connect, tell me if you agree with my dry powder rule of thumb or if you think I am on way off base.

Greg Martin is an entrepreneur’s insider to the banking industry and passionately believes that every person was uniquely designed for a higher purpose and calling. Greg guides entrepreneurs in defining and achieving their purpose and calling. His deepest passion is living life with his wife and their wonderful son.