Sep 28, 2021How much cash should my business have on hand?
Responsible business owners will make sure to have enough cash in their business at all times to not only pay for expenses but also prepare for unforeseen circumstances. This begs the question—how much cash is enough?
How much cash is enough?
As a general rule, many have recommended that businesses should have enough cash to continue operations for three to six months. This rule, however, does not take into consideration the unique situation of diverse businesses. The purpose of this article is to provide advice on balancing cash and investments so that business owners can better assess their unique situation.
Which Industries Need More Cash?
Some businesses should have more cash on hand than others. For example, seasonal businesses may need to adjust their cash reserve depending on the time of year. Start-up companies also will need a bit more cash to keep up with their consistent growth during the early years. In any case, companies should analyze what stage their business is in to determine their need. A business will need more cash on hand when preparing for large purchases or product sales (Cash-Flow Management).
Can Businesses Have Too Much Cash?
While it may seem like having a consistent chunk of cash on hand is a good thing, it can be a warning sign for businesses. This is because too much cash can indicate that the company’s money is not being put to use properly. For example, if a company retains a large chunk of cash instead of investing a portion of it, they will be missing potential cash-return possibilities. Too much cash can also lull companies and management into a false sense of security, which can decrease company performance.
What Is an Appropriate Amount of Cash?
To determine the appropriate amount of cash a business should have on hand, businesses must analyze several factors. The following questions can help in understanding the appropriate amount of cash to keep on hand:
1) Calculate how much cash is needed to maintain normal business operations. Understanding what is needed to maintain normal business operations is the first step to setting aside an appropriate amount of cash to prepare for unforeseen circumstances. This can be calculated by subtracting monthly expenses from monthly sales to calculate the “net burn” (Cash-Flow Management). This monthly amount can then be multiplied by the number of months a business would like to prepare for, and the resulting amount would then become the cash reserve.
2) Analyze the company’s cash-flow projections. Businesses should have a financial plan or budget mapped out for at least a year into the future. Understanding financial projections can help businesses determine the amount of cash to hold for any upcoming or non-consistent expenses.
3) Determine how long it takes to get more cash. The amount of time it will take to acquire more cash will vary depending on how long the company’s cash life cycle is. For example, a loan will take more time than a business owner writing a check from his or her own reserves. Getting funding from angel investors can take even longer. On average, seeking a loan from a bank can take up to two months and seeking a loan from an angel investor can take six to nine months. Depending on which route a business chooses, it will need to adjust its cash reserve (Cash-Flow Management).
The Bottom Line
Several factors should be taken into consideration when maintaining a cash reserve in your business. While having more cash on hand may seem helpful, it can mean that the business isn’t using funds to their fullest capacity. A low amount of cash can also be detrimental to a business, which is why businesses should determine how much cash will be sufficient for its needs using the above guidelines. When in doubt, experts recommend using reasonably conservative estimates since cash-flow projections can never be perfectly accurate.