Tips for making sure you have the right amount of cash on hand
Small business owners understandably often focus on cash flow management. But as important as cash flow is to the ongoing success of a business, savings or cash on hand can also be key.
Why do companies keep cash reserves?
Businesses with a savings cushion can handle unexpected expenses like surprisingly high materials cost, unforeseen shipping costs, or the need to replace equipment without scrambling for financing. That’s especially true if you don’t have ready access to credit, forcing you to dip into personal finances. Inadequate savings can also keep business owners from growing the business — whether it’s a new location, bigger office space, or expansion into a new market.
Think of cash reserves as a business emergency fund. Here’s a look at how much small business owners should save and where to keep the cash. You can also use our worksheet to gauge where your business is with these metrics.
How much cash reserve should a small business have?
There’s no one-size-fits-all rule, but generally, small businesses are advised to set aside 3-6 months of expenses in cash reserves. Exactly how much that is for you can vary, depending on a few factors:
- Monthly expenses
Look at how much cash your business uses every month. You can do this by reviewing your monthly cash flow reports and adding up recurring categories such as payroll, rent, supplies, and marketing costs. You’ll want to review several months’ worth of reports to capture expenses that don’t necessarily come every month.
Another way to tally monthly expenses is to find the burn rate, or the rate at which a company uses money. To do this, review several months of cash flow reports and calculate the amount of cash you have at the beginning of the period and the amount of cash at the end, then divide by the number of months you’re looking at.
So if you start with $160,000 in cash and end with $100,000 after 3 months, your monthly burn rate is $60,000 ÷ 3 = $20,000 per month. Using the burn rate is useful for startups or other early-stage small businesses that aren’t yet making a profit.
Tip: Consider working with a bookkeeper or using accounting software to help you plan, track and control the cash moving in and out of your business. Having an accurate estimate of monthly costs can help you set aside a consistent amount.
- Upcoming expenses
Consider growth plans or big expenditures in the next 12 to 15 months. If your business is growing, the anticipated increase in sales could cover some of the additional expenditures. To make sure you’ve covered your 3-6 months’ expenses, consider how much you might draw from the sales increase and how much from savings.
Tip: Have you written a business growth plan or updated your business plan? Growth may also include additional spending on technology or people. Taking a holistic and long-term look at the business can help you plan better.
- Business environment
Consider external factors that could impact your spending. When there’s a lot of uncertainty or a looming recession, it’s a good idea to have more savings.
Also, consider your type of business. If your business is seasonal or very sensitive to economic downturns, keep 9 or even 12 months of expenses saved up.
- Business growth
Evaluate the phase your business is in. Early-stage small businesses burn through cash more quickly than mature businesses. Mature businesses also tend to have more predictable cash flow and expenses. If your business is in a fast growth phase, you may want more cash on hand to provide a cushion against unexpected drops in revenue and to fund expansion plans.
- Credit
Access to credit funds is crucial to growth and expansion. Moreover, if you have access to credit you may feel comfortable with savings that are on the lower end of the recommended range.
There are many borrowing options available, and you might consider talking to your banker to see what might be a good choice for your business for future or current needs.
Tip: Check to see how much cash you have on hand. If you have a line of credit, check how much you have available and the current interest rate. You might also contact your banker to look into getting a loan and the rates on those. Read more about how to get ready if you need one..
How much cash will your business need in the future?
While not having enough in cash can be detrimental, having more than the recommended amount isn’t necessarily better for business, either. Having excess cash can curb growth, especially if your business is an early-stage startup that could put that money toward expansion.
Having the “right amount” in cash is a moving target, so this is a process you’ll need to revisit every now and then as your business, and the business climate, changes.
Where to keep your cash
Small business cash should be easily accessible. Business owners may choose to keep cash in a checking account or a business savings account. Also, savings doesn’t necessarily have to be in cash. You could also keep it in short-term Treasury bills, money market accounts, or CDs.
Talk to a banker to weigh your various options for keeping your cash reserves. Interest rates can vary depending on the type of account, so it’s worthwhile gathering information on your options before making a decision. Just keep in mind that interest rates are one of several factors to consider when evaluating accounts. Customer service matters too.
Use our small business savings worksheet to determine the amount that’s best for your business.
