How Much Cash Should I Keep in My Business Cash Reserves?
Too much cash in your business can be a waste; not enough can be downright dangerous. Striking the right balance in your business cash reserves is key, but it’s a delicate dance that requires careful consideration and strategic planning.
Rule of Thumb: The 2-Month Benchmark
A good rule of thumb is to keep the equivalent of two months’ worth of all expenses. This includes payroll, cost of goods sold (COGS), overhead, and debt payments. Why? Because running out of cash isn’t just inconvenient; it can be disastrous. To safeguard against this, having a credit card and arranging a line of credit is wise before you find yourself in a pinch.
Rationale Behind Having Two Months of Business Cash Reserves
We used to joke about “business just stopping one day,” but the pandemic made that a reality. Keeping two months’ business cash reserves on hand can help weather such unforeseen events.
Other potential disasters might include customers who default on payments, a bad batch of products leading to returns or discounts, or a PR mishap that slows down your sales (be careful what you say on TikTok!).
Why Not Keep More?
While having enough business cash reserves is crucial, holding onto too much cash can lead to problems. Employees might become careless with spending, and you may stop watching your money closely; this can lead to errors or even fraud. Additionally, excess cash can negatively impact your company’s valuation, particularly if you’re looking to sell.
A buyer may see how much cash you have in the bank and (mistakenly) assume that is how much cash your business needs to stay healthy. The more cash is needed to run the business (called “working capital”) the less a buyer is willing to pay you!
Too much cash does not add value
Cash sitting in the bank isn’t working for you. (Investing in growth would be an exception to this. To learn more about that, read our previously published article on Return on Invested Capital or ROIC.) Either take your excess capital home or invest it.
If you have a little extra, consider putting it in a CD or other safe investment, especially now when rates are over 5%. For those with more business cash reserves, consider distributing it to owners, investing in bonds, or getting creative by investing in your customers’ or vendors’ companies.
At Fuse, we’ve made over five private investments. We have invested extra cash into our customers, our vendors, and even a general “Angel Investment Fund.” Frankly, the results have been outstanding. We have better relationships with customers, better alignment with partners, and happier employees fully committed to their clients.
Advanced Tips for Cash Management
Want to increase your cash on hand? There are several tricks to keeping as much of it as possible. Here are a few tips:
- Maintain a 13-Week Cash Forecast: Keep an eye on your future balance.
- Measure Your Cash Cycle: Work to reduce the cycle days and free up more cash.
- Evaluate ROIC (Return on Invested Capital): Decide where the best use of your cash is.
- Always Have a Growth Plan: Even if it’s not actionable today, having a plan ensures you’re ready to maximize future investments.
Maximize Your Business’s Potential
No matter how much cash you keep in the company, Fuse can help you navigate your business’s financial journey. Our free, no-obligation business analysis focuses on enhancing your growth and profitability. We’ll assess your financial health, explore cash flow strategies, and ensure your accounting is on point.
Ready to unlock new opportunities for your business? Schedule your free analysis now.
