As a small business owner, you might not have easy access to a lot of cash. But, there are times when you need to cover larger, sometimes unexpected, expenses. Prepare your business for unanticipated costs with a cash reserve.
What is a cash reserve?
A cash reserve is an emergency fund for your business. You use a cash reserve to meet unplanned, short-term financial needs. Instead of incurring debt from a credit card or loan, you can pay unanticipated costs with money from your cash reserve. Usually, you save money for your cash reserve in a business bank account.
How much goes in a cash reserve?
Most financial experts suggest a cash reserve should be able to cover three to six months of expenses. But, there is no one-size-fits-all amount of a cash reserve. You need to look at your financial needs to determine how much money to keep in your cash reserve.
You can decide how much to keep in your cash reserve by looking at your business’s expenses and earnings.
If you have an established company, review your past expenses and earnings. Your small business cash flow statement will help you determine how much money to put in the cash reserve.
Use a cash flow statement from the previous year to find the revenue and money you spent. Subtract the expenses from the revenue. That figure is your cash burn rate, or the amount of money you lost from expenses.
Multiply your net burn rate by the number of months you want to save for in your cash reserve. For example, if you want a cash reserve that will last three months, multiply the net burn rate by three.
You can also use your business budget and projected cash flow to determine the size of your cash reserve. Subtract projected sales by projected expenses. Projections are helpful for startup businesses that do not have previous financial statements.
Make sure you look at all your business expenses. You need enough money to order materials and pay employees.
You also need to save for overhead costs. Overhead costs include rent, utilities, and insurance. No matter how much revenue you make, you have to pay the same amount of overhead costs. You can use your cash reserve to pay overhead costs when sales are low.
How do I start a cash reserve?
You can save your cash reserve in a bank account. Using a business savings account gives you fast access to your cash reserve. You also earn interest as you increase the cash reserve.
Set a goal for saving in your cash reserve each month. It could take about six months to a year to grow your cash reserve. Start by saving according to your goal and adjust deposits as it is necessary.
Why should I have a cash reserve?
You know it’s a good idea to have extra cash on hand for your company. But, what is a cash reserve going to do for your business?
A cash reserve can help you prepare for unpredictable costs. Though there are many reasons to have a cash reserve, here are three important ones to keep in mind:
1. You prepare for unexpected expenses. Whether your vehicle breaks down or you forget to pay an invoice, there are times you need to make a payment fast. A cash reserve protects you from financial issues due to unexpected expenses.
2. You are open to growth opportunities. There are times that you have opportunities to earn more revenue and grow your business. But, these opportunities often require you to spend money first.
For example, a customer wants you to complete a big job. You need to pay for the materials, supplies, and payroll before starting the work. A cash reserve allows you to take on a larger job and get a larger payout when you are finished.
3. You can borrow less from loans. Small business loans are a part of operating a company. But, a cash reserve allows you to take out fewer loans. Instead, you use your cash on hand to make payments. By using a cash reserve, you don’t have to worry about loan payments or accruing loan interest.
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