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For most businesses, cash reserves are a critical tool for meeting liquidity needs such as paying your bills on time! A study from JP Morgan Chase even treats them as an accurate measure of a business’ vitality and security. Despite their importance, however, many businesses struggle to keep enough working capital.
Cash Reserves Serve Multiple Functions
Cash reserves are essential both for day-to-day operations and for whatever the future might hold.
On a daily basis, reserves are needed to help manage a business’s cash flow. Suppliers must be paid and employees want their salaries, and those expenses have to come out of a business’ coffers. Some operating costs, such as an installment payment might be delayed (at a cost), but others will halt a business if they aren’t paid on time.
When unexpected disruptions occur, reserves act as a financial buffer against any loss of income or increased cost. They can be used to continue paying operating expenses when revenue streams are suspended, or they can pay for repairs to facilities or equipment. Whether impacted by a disaster or a broken piece of machinery, having a buffer available is often the difference between survival and financial peril for small businesses.
Finally, reserves give businesses the ability to take advantage of any opportunities that come along. When the chance to purchase supplies inexpensively, launch new products or expand into new territories comes along, having cash on hand ensures that a business can do so.
Small Businesses Lack Cash Reserves
Despite their importance, the study by JP Morgan Chase found that most businesses have only a small amount of cash reserves.
On average, small businesses have a daily cash balance of $12,100. This may seem like a decent amount, but it covers a mere 27 days of operating expenses for most businesses. Having less than a month’s worth of cash reserves is certainly not ideal, and it’d be preferable to have even more than a month’s supply in many cases.
Moreover, this is only an average of all businesses. The number is skewed by machinery and high-tech manufacturing businesses, which have median cash reserves that are over double the average of all small businesses. Businesses in many other industries have far lower reserves:
Even businesses that have substantially more working capital, such as wholesalers ($18,500) and restaurants ($16,000), frequently can’t cover their operating expenses for long. Those figures account for just 23 days of wholesalers’ and 16 days of restaurants’ operating expenses.
Businesses Can Increase Their Working Capital Several Ways
While not always easy, there are ways that businesses can increase their cash reserves: