Building a Cash Cushion for Your Business

297

Cash on hand or cash in reserve refers to the financial assets that are immediately accessible. This cash cushion typically includes assets like physical cash you have in your store, the balance of your business checking account, and funds that are easy to access like your business savings account.

Saving up enough cash to cover expenses for a few months can improve liquidity and make your business more resilient.

The Benefits of a Cash Cushion

Falling behind on your financial obligations means that you would incur late fees or might have to borrow money to cover expenses like payroll. You might also have a hard time with keeping inventory in stock or purchasing raw materials.

As a business owner, you’re aware that sales and cash intake can vary. Some industries see a seasonal peak, and a wide range of events can cause sales to slow down for a while.

Most of these factors are difficult to predict and are outside of your control. A natural disaster can disrupt operations, a new competitor can take market shares away from you, and something like an order cancellation or unpaid invoice can slow down your cash flow.

Keeping enough cash on hand to cover expenses for a few months will help you maintain operations in these scenarios. You should also know that cash on hand will increase your business valuation, which is an advantage if you’re in the process of applying for a loan or looking for investors.

How Much Cash on Hand Do You Need?

You need to determine how much cash on hand you need to stay afloat if demand slows down. Failing to save up enough cash could make it challenging to meet your financial obligations and increase your risk of bankruptcy.

However, saving more cash than you need would take away from the capital you could use for growth. Growing your business requires investing in things like research and development, inventory, machinery, or marketing. A large cash cushion means that you will have less capital available for these different investments.

Your cash flow statements are an excellent place to start to assess your monthly expenses. You can use these statements to identify your different expenses, including:

  • Recurring expenses like payroll, rent, utilities, loan payments, and production costs.
  • Variable expenses like inventory, taxes, and marketing.

If your industry is seasonal, go over your cash flow statements for the past year to identify the months with the most and least expenses.

Experts recommend saving up enough cash to cover between three and six months of expenses. If you operate a seasonal business, make sure you have enough cash to cover expenses during your busiest month.

You can adjust that amount based on your needs and the growth stage of your business. Saving enough cash to cover six months of expenses might not be necessary and would take valuable capital away from necessary investments.

If your business is in an early stage of growth, or if you’re about to invest in an expansion strategy, you need to take growth projections into consideration. Using your current cash flow statements isn’t going to reflect your future cash needs.

It’s best to use growth estimates to figure out what your average monthly expenses will amount to. You can then save up enough cash to cover expenses for a three to six months period a year from now.

You should also consider how easy it is for you to obtain more cash if needed, and how long it would take to secure more funds. If you have access to an affordable source of financing, keeping a smaller cash cushion on hand is acceptable.

Reviewing Your Financing Options

Obtaining more capital will help you address immediate financial obligations and give you a head start on saving for your cash cushion. Here are a few financing options to consider:

  • Apply for a small business loan. There are different SBA programs that make loans affordable, but there is a lengthy application process.
  • Credit lines are flexible and easy to obtain. The downside is that you will pay more for financing.
  • Invoice factoring gives you access to immediate cash flow for your existing invoices. The invoice factoring service will charge a fee or take a percentage of the invoice amount.
  • A crowdfunding campaign can be time-consuming, but it can be an effective way of raising capital through small investments.
  • Borrowing money from friends and family is a more affordable alternative to borrowing from financial institutions.
  • Angel investors can inject capital into a business venture, usually against owning equity in the business.

Keeping a comfortable cash cushion on hand will increase liquidity and make your business more resilient if you experience a drop in sales. You should ideally have enough cash to cover between three to six months of expenses.