How much cash on hand does your business need?

Most business owners would agree that having a cushion of cash on hand is essential for the health and longevity of their company. However, there is no universal answer to how much cash your business should aim to keep on hand.

Each business has to consider its situation and decide what works for them. You might have seen guidelines such as maintaining three to six months of expenses in cash. We’ll explore why your business should keep some money on hand and how to figure out how much cash your business needs.

Why is it essential for all businesses to have cash on hand

The best time to have cash on hand is before you need it.

For most businesses, cash on hand will include the money in their bank accounts, money market accounts, petty cash, and any assets you can reliably liquidate quickly.

Cash on hand is not just a nice to have but a necessity for many businesses. When you have funds available, you are free to take risks and make decisions in your business’s best interests. You can take advantage of new opportunities and weather any unpredictable or challenging times that may come your way.

Take advantage of opportunities.

Cash is essential for covering day-to-day expenses such as rent, payroll, and inventory. Beyond that, having funds available when you need them can be the difference between taking advantage of opportunities as they arise or passing them up.

For example, if a critical supplier offers a discount for bulk orders, you’ll need the cash to take advantage of that opportunity. Or, if you have the chance to lease a larger space at a favourable rate, cash on hand can help you expand your business.

Weather periods of low demand.

There will inevitably be periods where business is slow, and cash flow is tight. Low demand can happen for many reasons, such as changes in seasonality, consumer preferences or other factors out of your control.

Having a cash reserve on hand can help you weather these periods without worrying about your business’s survival. You will be able to continue to keep the lights on, pay your employees, and even invest in marketing if needed. The cash on hand will allow you to continue operating without having to make drastic cuts or take on unnecessary debt.

Prepare for the unexpected.

Running a business is unpredictable. Your company might run into unforeseen events such as bad weather, malfunctioning equipment, defective inventory, or macroeconomic or geopolitical events.

It is impossible to predict and be ready for all these possibilities. However, when you have a healthy cash reserve, you can weather unexpected events and any costs that may come with them.

Six tips to determine how much cash your business needs

A recommendation business owners often hear is to have enough cash on hand to cover three to six months of operating expenses. However, it is vital to ensure that the advice fits your business. You will need to evaluate whether you need more or less cash than this blanket recommendation.

Review your business forecasts

If you already have financial forecasts, these can help you understand your ongoing cash needs. Your in-house or outsourced accounting team can help you build and update your financial forecast quarterly or annually. A forecast can help you understand how much cash your business needs in the upcoming months by looking at typical requirements and factoring in seasonality or one-time events like new product launches or research and development.

Look at how much you typically spend in a month.

If you don’t have a financial forecast, a great place to start is by asking yourself, how much does your business typically spend in a month?

Past expenditures can provide you with insight into the typical cash flow of your business. As a starting point, you might average the last few months, or if you have a seasonal business, you might look at prior years to predict your future needs. Once you have a starting point, you can tweak this based on any additional information, such as any one-time payments or other new events in your business.

Analyze your accounts receivable and payable terms

Another way to get a sense of how much cash your business needs is to look at your accounts receivable and payable terms.

• How long does it take your customers to pay you?
• How long do you have to pay your suppliers?

Knowing the answers to these critical questions about your cash conversion cycle will give you a good idea of your cash flow needs and help reduce interruptions in your business to keep things running smoothly.

Take a clue from your industry peers.

Your business’s industry and the business model can help determine how much cash you need on hand.

For example, companies that require inventory or raw materials, such as retail, or manufacturing, may need more funds available on hand than service-based businesses. They’ll need to be able to pay for these items when they’re due.

Other businesses, such as real estate or subscription-based companies, may be able to forecast their cash flow more reliably based on customer contracts or leases. As a result, they might need less cash on hand.

Determine your stage of growth

Another factor that plays a role in how much cash you need is the growth stage of your business. Typically, the older, and more mature your business, the more reliably you might be able to forecast your cash flow. If you are operating a startup or business in the early stages of growth, you’ll likely burn through your cash quickly as you invest in product development, marketing, and hiring. Conversely, if you are operating a mature business further along its growth cycle, you’ll likely need less cash.

Consider your short-term financing options.

Of course, even if you don’t have a lot of cash on hand, you may be able to raise funds when you need them quickly. If you are an established business with a pre-approved line of credit with your bank, you may not need to have too much cash on hand, knowing that you can access funds when you need them. Younger businesses might find it harder to get cash or loans when they need them. As a result, younger companies need more cushion in their cash flow to survive unpredictable periods.

Get a second opinion.

If you’re still unsure how much cash your business needs, it’s good to speak to an accountant or financial advisor. With their expertise, they’ll be able to help you assess your financial records and give you guidance on how much cash you need to keep on hand.

Bottom line

Having a healthy cash reserve is essential for any business. Having enough cash on hand can help your business survive when unexpected costs show up and allow you to take advantage of growth opportunities.

The amount of cash your business needs on hand will depend on several factors that are unique to your business.

Once you understand your monthly cash flow needs, you can build up a cash reserve to ensure your business remains healthy and prepared for whatever comes its way.

Contact KSSP Partners LLP in Markham for Financial Advice for your Business

At KSSP Partners LLP, our business planning experts can provide you with personalized recommendations on how much cash your business needs on hand and improve operations to generate cash flow. To learn more about how KSSP Partners LLP can provide you with the best business planning expertise, contact us online or by telephone at 289-554-5997.