If you’re a small business owner, having a cash reserve is more than just about saving for a rainy day. According to research from U.S. Bank, nearly four out of five small businesses (82%) fail due to cash flow issues. And for many small business owners, the COVID-19 pandemic further revealed how unexpected setbacks can maximize existing vulnerabilities.
A business cash reserve can help protect you from the many challenges entrepreneurs often encounter while running a business. Fortunately, there are steps you can take to fortify your business and preserve the free cash flow you need to maintain and grow your business.
There are many benefits to building a business cash reserve. Three common examples include meeting emergency needs, making major purchases, and preparing for future growth.
Having extra funds on hand is crucial for covering the “What if?” scenarios that can affect your business. For example, what if:
- Your company vehicle needs repair?
- You need to order new inventory?
- You have to make changes to your property?
Every business owner is likely to incur unexpected expenditures at one point or another. A cash reserve can help you prepare for this possibility so you don’t have to borrow from other parts of the business (or your personal savings).
As your business grows, your expenses will naturally increase as well. Unfortunately, you may not have the free cash flow you need to invest in new equipment or employees right away.
A business cash reserve can help bridge the gap between new business opportunities and the ensuing revenue. It can also help you avoid taking on a business loan, which can be more expensive and create additional risks for your business.
Successful small businesses tend to plan ahead, whether that means preparing for the unexpected or future growth prospects. A business cash reserve can give you more flexibility as you strategically plan for ways to scale your business. This may include:
- Purchasing additional inventory
- Investing in marketing
- Hiring new staff
- Opening a second location
These activities all require funding. While a business loan can help, a cash reserve often allows you more control over how and when you direct your funds to pursue new opportunities.
Ideally, your business cash reserve should be enough to cover your expenses for at least three months. However, depending on the nature of your business, you may want to have enough cash on hand for at least six months.
Indeed, setting cash aside can be difficult, especially for new business owners. Initially, every dollar counts for the survival of your business. Still, you can develop a plan that allows you to grow your cash reserve over time.
Start by sitting down and calculating your fixed business expenses. In other words, determine the minimum amount you need each month to sustain operations. This will give you a starting point for how much cash you need to set aside.
Then, calculate how much cash you can reasonably save each month after you cover your expenses. If you don’t have any cash leftover, you may want to reconsider your pricing or reduce expenses where possible.
To avoid finding other uses for your cash reserve, consider automatically transferring a set amount each month to a separate account. For example, Justin Goodbread of Heritage Investors recommends that business owners set up a MOOSE account.
A MOOSE account refers to “Monthly Out-Of-Sight Expenses.” In other words, start a bank account that’s entirely separate from all your other operating expenses or business income. Use this account solely to build up your business cash reserve.
A Goldman Sachs survey revealed that 44% of small business owners have less than three months of cash savings on hand. If your business falls into this category, here are some tips to help you build your business cash reserves:
Start small. Set a monthly goal of how much money you intend to put away for savings and try to meet this goal each month. Remember, your final goal is to have three to six months of reserves. However, a monthly target can help you work toward this goal without being overwhelming.
Your business has a variety of outside obligations. But it’s important to remember that meeting these obligations depends on the survival of your business.
To help ensure you have enough money each month to contribute to your cash reserves, consider categorizing savings as a fixed expense. Then, set your prices accordingly so there’s no question whether this money will be available each month. (Though not relevant to this blog post, this strategy can help you build your personal retirement savings, too.)
As a business owner, it’s critical to stay on top of your books. Many companies waste money on unnecessary expenses that can reduce their free cash flow.
When possible, trim the fat. In addition, try to operate with as lean a budget as you can so you’re not overextended if you experience a setback.
One of the reasons businesses struggle with cash flow is that they accumulate a backlog of unpaid bills and outstanding invoices. Consider encouraging your clients to pay on time by enforcing penalties for late payments. Alternatively, try offering a discount to customers who pay in advance.
If you need to dip into your cash reserves, don’t forget to pay yourself back in a timely manner. Make it a habit to repay yourself after a withdrawal so you can maintain a consistent (or growing) cash fund.
There’s only one “bad time” to start thinking about your business cash reserves: when the crisis is looming over your shoulder. Instead, set up a process to build your business cash reserves as soon as possible—and be sure to stick to it.
And don’t forget to consider your insurance options. The right policy can also help protect your business against an unexpected setback. Together, these strategies can help your business thrive for years to come.
Oak Capital Advisors specializes in financial planning for business owners. If we can help you develop a strategy to build your personal and/or business savings, please schedule an introductory call. We’d be happy to hear from you.