Key Takeaways
- Cash on hand in business refers to funds that are readily available for unexpected costs, which are typically “rainy day” circ*mstances.
- Cash on hand can include funds from various sources, such as actual cash, bank accounts, and liquid assets that can be easily converted into cash.
- Determining how much cash on hand should be set aside depends on many factors, but it is generally advised to reserve between three and six months worth of expenses.
Definition and Example of Cash on Hand
Cash on hand is essentially a money reserve available after all regular expenses have been considered. Generally regarded as funds set aside for “rainy day” circ*mstances, cash on hand may be used for a variety of reasons, whether it’s to offset a spike in rent, take advantage of beneficial investment opportunities, or cover expenses associated with damage to equipment.
Cash on hand comes in various forms, from actual cash to funds in a business checking account. Businesses also consider assets that can quickly be liquidated or sold as part of their cash on hand; this is especially useful when businesses don’t have much cash to rely on.
As an example, cash on hand would be the equivalent of a business's cash, cash equivalents, and other short-term investments that can be quickly liquified in the event funds are needed.
Businesses may have different outlooks on how liquid assets are classified as cash on hand or how quickly they can be converted, as well as how much cash on hand is adequate. This may depend on a number of factors, including the industry and the geographic location.
How Cash on Hand Works
Cash on hand is used like a savings account, but money is only withdrawn if it’s absolutely needed. Funds are saved up for a “rainy day” or to cover much-needed expenses to keep the business running. To ensure cash on hand can cover these extra or unexpected costs, it is important to calculate funds accurately.
Cash on hand is generally calculated by determining the cash flow of the business. Cash flow refers to the money that flows both in and out of the business. The cash flowing in would include sales from customers, while the cash flowing out would consist, for instance, of money paid to cover the cost of inventory.
Businesses may benefit from creating a cash flow projection, which is an estimate of the cash inflows and outflows in a specific period. Determining the balance on the cash flow statement can provide a more accurate account of the cash on hand that is expected.
Here is a simple way to calculate your business’s ideal cash on hand amount:
Cash Reserve = (Total annual expenses / 12) x [3, 4, 5, 6, n] months
- The numbers in brackets should correspond to the number of months you want to cover with your cash reserves. The rule of thumb is to have enough cash to cover three to six months of operating expenses.
- Use your cash flow statement to determine your total business expenses for a given year.
- Divide your total expenses by 12 to arrive at an estimate of your typical expenses per month.
- Multiply that number by the number of months you determined above. That will be the ideal amount to keep in your cash reserves.
Businesses that have a tendency to fluctuate or can’t clearly forecast their cash inflow during their growth stage should also set aside a decent amount for their cash on hand account to use as needed. The economy can also be a good indicator. Trends such as an increase in interest rates for business loans or inflation on capital goods can affect the amount of funds a business should set aside to cover possible future expenses.
Types of Cash on Hand
While there is generally only one concept of cash on hand, it can include money or funds in various forms. Some examples of different forms of cash on hand may include:
- Actual cash, including petty cash
- Bank accounts (both both checking and savings accounts)
- Liquid assets, which can be quickly converted into cash
Note
Some businesses often use the term “cash on hand” interchangeably with “petty cash,” since both cover unexpected costs. Petty cash typically refers to a specific account with limited funds to cover basic, small expenses; however, it are still considered part of the overall cash on hand since it is readily available.
Research shows that 50% of small businesses can only cover 15 days worth of experiences from its cash reserves in the event of a disruption. To increase cash on hand, it’s important to work toward increasing cash flow in general. Simply increasing sales or decreasing debt is key. Conducting market research and making price adjustments may help boost sales.
