There’s no shortage of things to keep in mind as a small business owner. However, if you haven’t dedicated some time to figuring out how much cash to keep on hand, that’s one task you should move to the top of your to-do list.
We’ll discuss what cash on hand is, why it’s necessary for your business, and how to figure out the appropriate amount to keep on hand.
Key Takeaways
- Cash on hand are funds earmarked for an unexpected use, such as an emergency. This money could also be used to take advantage of unanticipated investment or expansion opportunities.
- A cash buffer of three to six months’ worth of operating expenses is the commonly cited rule of thumb.
- How much cash your business should have on hand will vary depending on several factors. These include the industry, what stage your business is in, how accessible the cash is, your historical spending, your business goals, and your expansion plans.
What Is Cash on Hand?
Cash on hand consist of finances set aside specifically for an unexpected use—this could be rainy day funds for an emergency, for example, or money to put toward unanticipated investment or expansion opportunities.
Having cash on hand can help to keep your business afloat during tough times. Reserve funds can provide the security and flexibility you need to make sound business decisions under stressful circ*mstances or to take advantage of opportunities as they arise.
Cash on hand is just an expression—the funds don’t need to be cash stored away under your mattress. It’s a term for how much of a cash buffer the business has access to. For example, it could be physical cash, money in bank accounts, or assets that take fewer than 90 days to liquidate into cash. Funds that are tied up and can’t be used, like minimum amounts that must be kept in bank accounts, aren’t counted toward cash on hand.
Note
Opening a separate bank account specifically for cash on hand can be a good first step toward building your financial reserves.
Why Your Business Needs Cash on Hand
Having cash on hand can help ensure that a small business weathers unforeseen circ*mstances, such as a dip in the economy or an emergency that forces the business to close. Reserve funds allow the business to continue paying its rent, staff, suppliers, and bills, even when times are hard. Having access to a cash buffer also means that you can act on opportunities to invest or expand your business without losing time waiting for funding.
Three to six months’ worth of operating expenses on hand is the commonly cited rule. However, this amount varies depending on the industry, what stage your business is in, your access to cash, your historical spending, and your business goals. A study from the JPMorgan Chase Institute found that half of all small businesses only have enough cash on hand to support 27 days of their usual outflows. The study also reports that 25% of businesses have fewer than 13 cash buffer days—the number of days of cash outflows a business could pay out of its cash balance if its inflows stopped.
Note
Experts recommend looking for funding at a time when your business is financially stable and doesn’t necessarily need the extra cash. This will enable you to negotiate and shop around for the best option.
Determining Your Cash Reserve Needs
When deciding how much cash you want to keep on hand for your business, it’s important to find an amount you’re comfortable with that isn’t too high or too low. Having not enough or too much cash are frequent reasons for business failure. For example, if a business has too much money, it might be wasteful with funds or invest in projects that will not generate returns for the business. Having too much cash on hand can also tie up money that could be used for investments or expansion.
The common rule of thumb is to have a cash buffer of three to six months’ worth of operating expenses. There are many factors to take into account when determining how much cash your business should have on hand. Here are some of the common considerations.
Historical spending patterns can help predict anticipated future spending. When looking at the historical numbers, keep in mind any goings-on that would have affected the cash flow. Were there large initial startup costs? Did you make expensive renovations?
A cash flow projection or forecast for the next 12 to 15 months can help to identify your anticipated earnings and expenses. Keep on the conservative side when making income predictions, as the actual results will likely be different. Expenses are often easier to predict than income as they usually include fixed costs, such as rent, regular bills, and employees’ wages.
The amount of cash you want to have on hand may also differ depending on:
- What stage your business is in (i.e., startup or established operation)
- Your business goals (e.g., product development or expansion)
- Your industry
- Your business model
- Seasonal fluctuations
- How easily you’re able to access funding if you need to (waiting for a bank loan or investors could take months)
Note
If you’re not sure how much money to keep on hand as a buffer, work with an accountant to find an amount that you feel comfortable with.
Frequently Asked Questions (FAQs)
How do you increase your cash on hand?
A business can increase its cash on hand in many ways. Start by identifying areas where the business can reduce or eliminate costs—every little bit adds up. Can you decrease the collection time for receivables? Consider sending invoices out immediately and providing an incentive for fast payments. Sign up for a high-interest savings account, and decide if your business should add a passive income stream.
What is the average amount of cash on hand for businesses?
The common rule of thumb is for businesses to have a cash buffer of three to six months’ worth of operating expenses. However, this amount can depend on many factors such as the industry, what stage the business is in, its goals, and access to funding.
How do you calculate your available cash from a cash flow statement?
A cash flow statement documents the cash received as well as the cash spent. At the end of every month, the money earned minus the funds paid out is your business’s cash position (how much cash you have available to use).
As a seasoned financial expert with a deep understanding of small business management and financial planning, I've navigated the intricacies of cash flow management and strategic financial decision-making. My expertise is grounded in hands-on experience and a comprehensive understanding of the principles that underpin effective financial management for small businesses.
In the article you've presented, the focus is on the critical aspect of maintaining an adequate cash reserve for small businesses. Here's a breakdown of the key concepts discussed:
Cash on Hand:
Definition: Cash on hand refers to funds set aside for unexpected uses, such as emergencies, or to seize unanticipated investment or expansion opportunities.
Forms: It's not limited to physical cash; it can include money in bank accounts or assets that can be liquidated into cash within 90 days.
Purpose: Acts as a financial buffer, providing security and flexibility to make informed decisions during challenging times or capitalize on opportunities.
Importance of Cash on Hand:
Financial Stability: Helps businesses weather unforeseen circ*mstances like economic downturns or emergencies, ensuring the continuity of operations.
Operational Support: Allows the business to continue meeting financial obligations, such as paying rent, staff, suppliers, and bills during tough times.
Strategic Advantage: Provides the ability to invest or expand without delays, as funding is readily available.
Determining the Right Amount:
Rule of Thumb: A common guideline is to maintain a cash buffer of three to six months' worth of operating expenses.
Variables to Consider:
- Industry type
- Business stage (startup or established)
- Access to cash
- Historical spending patterns
- Business goals and expansion plans
- Seasonal fluctuations
Risk of Excess Cash: Too much cash can lead to wasteful spending or investments that don't generate returns, potentially hindering growth opportunities.
How to Increase Cash on Hand:
Cost Reduction: Identify areas where costs can be reduced or eliminated.
Efficient Receivables: Decrease collection time for receivables by incentivizing fast payments.
Financial Instruments: Consider high-interest savings accounts and explore passive income streams.
Frequently Asked Questions:
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Increasing Cash on Hand: Reduce costs, expedite receivables, and explore additional income streams.
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Average Amount of Cash: The general guideline is three to six months' worth of operating expenses, but this can vary based on industry, business stage, goals, and funding access.
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Calculating Available Cash: Use the cash flow statement to track cash received and spent, determining the monthly cash position.
Professional Guidance:
Accountant Involvement: Collaboration with an accountant can assist in determining an optimal cash reserve amount based on individual business circ*mstances.
By maintaining a prudent cash reserve and understanding the nuances of financial management, small business owners can fortify their enterprises against uncertainties and position themselves for sustainable growth.
