In personal finance, experts advise to keep enough cash in savings to run your household for 6 months. This is true in business, too. In fact, having a substantial safety net can mean the difference between staying in business or going bankrupt. Here are some tips on how much cash should be kept in reserve for a business.
Prepare for Negative Cash Flow
Every business is bound to have a few months of negative cash flow, especially starting out. This negative balance can be dealt with by using cash that is set aside for this purpose, selling assets, or raising capital. However, eventually, the business will have to turn a profit, or the business will be unable to remain afloat.
Consider the Size of the Safety Net
Determine the volatility of the business. Is the business a seasonal one or is it one that might be volatile without warning? Asking these questions will help to determine how much cash is needed to keep the business running. If there are windfall months, determine how much of that cash will be put back for the lean times. It all depends on the type of business.
Find a Balance
If a company leases equipment, one benefit for that company is the amount of capital on hand that can be sold to get cash. Beware though, if a business sells all of its capital, or too much capital, it will eventually have to replace that capital or switch from leasing to selling. Finding a good balance between leasing and selling equipment can be a viable future for a company that solely leases out equipment.
If a business relies solely on selling goods or services, then it will be at the mercy of the demand for their goods or services. It is imperative that a company be frugal with spending so that it is not caught in a downward spiral of generating cash flow without a plan of how to use that cash to advance the business.
Don’t Save Too Much
This may sound contradictory but saving too much cash can be too much of a good thing. Instead of amassing vast amounts of cash that is just sitting around, put it to good use in the business. Invest the cash in growing the business or give it back to shareholders.
Understand how much liquidity the business needs, develop a plan to deal with unexpected negative cash flow, and make plans for the future of the business.