Your business needs cash. Cash keeps your business operating and enables you to grow, so you should already know how much cash your business needs to survive. Many people assume the answer is linked solely to operating expenses. However, this isn’t the case.
Not one factor can determine the amount of cash your business will need to have on hand. Somewhere between 3-6 months of operating expenses is a good baseline to start from, but there’s more to it than that.
Here are some factors that determine how much cash your business needs.
Your income
The source of your income will help determine what cash you need. If your income isn’t highly varied—that is, if the majority of your income comes from one or two main clients—you will require more cash on hand. This is because if your main client decides to leave you, suddenly you find yourself with significantly less money coming in.
Having a varied income means you will be better equipped when losing a client, so you’ll need less cash available. However, if your primary source of income is only coming from one source, you need to be prepared to have only a little income if they leave.
Additionally, if your business has investors, they could request their money back at any point. You will need to be able to cover that.
Your expenses
Typically businesses have variable overhead expenses and fixed expenses related to the cost of goods sold. You need to know how each of these affects your business over a few months so you can prepare to cover them.
You will need to look at your financial statements for a period of no less than six months; also, make sure you are consistently accounting for busy periods and slow periods. See how and where your money is being spent and the average amount of money needed to cover those expenditures.
Your assets
Liquidity refers to how easily your assets can be turned into cash. Any bond and stocks you might have can easily be turned into cash. However, property and equipment are less liquid because these things often take time to sell.
You will need less cash the more liquid your assets are. However, not having a lot of liquid assets means you’ll want more cash accessible.
Your spending situation
This is based on how much of your expenditures are discretionary and how much are mandatory- that is, you can operate without those expenses. If a high proportion of your costs are mandatory, you will need to have cash available to cover you if times get tough.
Discretionary expenses can be cut without necessarily affecting business, saving you money or freeing it up for mandatory expenses.
The more fixed your spending situation is, the more cash you’ll need on hand.
Final thoughts
The final important factor is opportunity cost. Having money to cover emergencies and downtimes is all good, but having too much money in the bank means you will miss out on investments that could build your wealth and quickly be turned into cash. Take time to talk to a financial expert that will help you understand your opportunity cost, and whether or not you need more or less cash available to you.
If you have any questions or would like some solutions to managing your cash requirements, feel free to Join the conversation…