Having too much cash can leave you skipping profitable investments or not paying yourself enough, but not having enough cash can leave you in a serious pinch. Here’s what you should consider when deciding the size of your cash reserves.
What Are Your Regular Expenses?
Most experts recommend that you keep at least three to six month’s worth of your regular operating expenses in cash. This is enough to get you through any temporary disruptions to your business as well as give you a cushion for sudden large expenses.
Your regular expenses include things like rent, salaries and inventory. Don’t forget to divide out irregular expenses on a per-month basis. In short, what’s your monthly budget?
What’s Your Business Cycle?
Does your business have ups and downs, or are things pretty steady all of the time? As business swings, so should your cash reserves.
- If you have a seasonal business, you’ll want to bulk up your cash during the busy season so you can coast through the slow months into the next busy season even if things are slower than expected.
- If your business is cyclical — that is, it rises and falls with a certain area of the economy — you’ll also want a larger than normal cash reserve.
Your goal is to think like a squirrel: How long will your winter be, and how many nuts do you need to save to get through it?
Do You Have Established Credit?
Having access to business credit can reduce your need for cash. The short-term interest cost of needing to tap into a line of a credit can be offset by the returns of having more cash invested for a longer period of time.
However, there’s a big catch. If the economy is down or your income is down, banks will be less likely to lend. Business credit might reduce your cash needs, but it can never fully replace having reserve cash.
What Are Your Potential Surprises?
Finally, what surprises might you face? Think both good and bad.
Do you have an important piece of equipment that would grind your business to a halt if it broke and you couldn’t immediately replace it? If you got a sudden large order, would you have enough cash to buy needed inventory or hire temporary employees to help with the rush? Your cash reserves should act both as a safety net and as a powder keg ready to take advantage of growth opportunities.
To get help figuring out how much cash you need to keep on hand or what steps you should take to build up your cash reserves,?schedule a consultation now.