This Is How Much Cash Your Business Really Needs
If there’s anything the recent economic downturn has taught us it’s that maintaining a healthy cash balance is critical for the survival of any business. But how much cash does your business really need? Brace yourself, because you might not like the answer.
That’s because the answer is not easy. Your business needs to have about six months of operating cash available at all times. That’s right, six months. In the bank. Or at least accessible.
What is operating cash? It’s the cash you need to run your business. To figure out that amount, just take a look at one month’s operations. What are the costs to operate your business over and above the margins you earn from sales? Add up all of your compensation costs, your rents, your utilities, your communications and your services. This is not just your overhead. It’s operating. So include what you’re typically paying for marketing, sales and administrative expenses too. Also, this is cash outlays, so make sure you’re including amounts you typically pay down on loans, taxes or even regular equipment purchases.
Let’s say that all of these payments add up to about $5,000 a month to operate your business, even if you’re not making any sales. That means that you should have at least $30,000 in cash available. When I told this to many of my clients pre-pandemic I was met with resistance and disbelief. That kind of free and clear money isn’t so easy for many small businesses. But that disbelief has turned into belief after what we experienced this year. My clients who have this cash available have been managing to survive this significant downturn.
Notice also the word “available.” If you don’t have cash on hand, do you have available cash? It may be both business or professional services. It could be cash values built up on your insurance. It may be a line of credit with a bank. It could even be available amounts under your credit cards. Sure, some of this credit is more expensive than others. But having it, regardless of the cost, when you really need it is priceless.
Your job is to build these cash and credit reserves. When you get to these levels you can take comfort that you’ve got enough operating funds to maintain your business regardless of many outcomes. Having cash in the bank will not only make you breathe and sleep easier in the event of a downturn but it will give you the confidence to make deals and negotiate purchases knowing that you’re doing so out of strength, not desperation. Knowing you can walk away from something because you’ve got the money in the bank is a good feeling and helps you make better decisions.
Of course, not all businesses are the same. Some businesses can get by with less than six months cash. Others that may be in seasonal industries might need even more cash availability to avoid larger purchases of inventory or to hire staff before things get busy. But in general, I’ve found that having six months of cash availability is the right rule of thumb for most of the clients I have.
I say this knowing that building up and maintaining a six-month cash availability reserve isn’t easy. If you stick to this limitation then you’re going to have some tough decisions to make. A lot of entrepreneurs I know can’t resist investing in a new piece of equipment, grabbing a big discount on a volume purchase or even just using excess cash for personal reasons. I get this. You’re not Scrooge and you can’t spend your whole life miserably counting your pennies. So go ahead and treat yourself. Make that deal. Buy that inventory. Take that vacation. Just do it after you’ve hit the six-month threshold, OK?
When the next downturn comes ‚Äì and it will come someday ‚Äì you’ll be thankful for doing this.