Business owners address many of their company’s financial aspects regularly. Equipment investments, profit margins, risk assessments and more can affect how well a business runs, and all of them should be paid attention to. Another aspect of running a business – cash reserves – is also important and, unfortunately, is sometimes overlooked.
In business, as in life, you should learn to expect the unexpected. Expenses can crop up seemingly out of nowhere, and if there isn’t cash on hand to meet them, potentially serious problems can arise for the business owner. Having an adequate cash reserve allows the business to take care of unexpected or emergency expenses and still operate smoothly.
How big should your cash reserve be?
Every business is different, therefore the answer to this question will be different for each business. Building up cash reserves should start early in the “life” of a business – actually there should be an accumulation of preparatory cash before the business launches.
The simple answer to the question of how large a company’s cash reserves should be is, it should be large enough to weather any financial setbacks and pay for any unexpected expenses. A business that’s running soundly knows its profit margins and how many sales are needed to stay profitable. It’s a simple money-in, money-out principle. The problem arises when cash beyond the usual operating amount is needed. With little or no cash available, a business can literally be frozen in place, with all upward momentum stalled.
Cash reserves are a critical part of liquidity
“Liquid” simply means available cash, i.e., cash you can get your hands on. This is differentiated from money tied up in investments or in other areas or ways that make it impossible to use that money now for real-time purchases. The more liquid a business is, the better it is able to fare well when more-than-usual expenses must be paid.
What kinds of things might a business need ready cash for? Here are a few.
- Purchase of additional inventory
- Unplanned marketing/promotional expenses
- Any damage to a building or its assets that isn’t covered by insurance
- Emergency repairs of equipment
- Investment in a new business opportunity
It’s difficult to plan perfectly for unexpected cash outlays. But by knowing the nature of your business and the types of expenses that could arise, you can aim toward a dollar figure of cash reserves that will sustain you and give you the freedom to make quick investments in infrastructure and growth that you feel are sound and warranted.
As noted, each business must decide how much liquid resources is necessary. Consulting with a professional in accounting and business planning is a good idea for business owners who know they haven’t got adequate cash reserves and aren’t sure how to develop them. But however you go about building and maintaining your available cash, the bottom line is make sure it gets done. The life of your business may someday depend on it.
Cotton Mather is a Pittsburg accounting and tax-preparation firm dedicated to helping small businesses succeed. If you’d like assistance with cash reserve issues or any other financial aspect of your business, we’d love to speak with you. Visit our website, or call us at (412) 931-1617.