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Your Business Should Have a Cash Reserve

Your cash reserve is one of your company’s most important but underrated components. Small-company executives pay little attention to it unless the company is in trouble. However, there is little you can do if your company is in trouble and you don’t have enough cash in reserve. You will be at the mercy of circumstances in a challenging environment.

Why is a cash reserve important?

A cash reserve is an essential component of a resilient business. It is your most important financial tool to ensure smooth operations. A cash reserve is typically used as an economic shock absorber. It allows your company to operate normally when faced with serious challenges. For example, you can use a cash reserve to handle unexpected expenses or to cover financial shortfalls.

Cash reserves also serve a strategic advantage. They allow you to capitalize on opportunities during recessions when other companies struggle to stay afloat. You will be one of the few financially stable glass subcontractors. Your company can take on projects without demanding fast payments from clients and general contractors. You can leverage this position to your advantage.

How big should the reserve be?

Opinions vary regarding the proper size of your emergency reserve. Some experts recommend keeping only a month or two of expenses, while other conservative views recommend three to six months.

Cash reserves also have an opportunity cost. The money in the reserve should not be used to expand the business or pursue new projects. Consequently, a large reserve may affect how quickly you can grow your business. You trade off growth for stability.

The best approach is to work with your CPA to determine a reserve size that meets your needs. Examine your financial reports and determine your monthly expenses during the past year. Use your most expensive months as a guideline for how much money to reserve each month. Ultimately, the reserve should match your requirements, risk tolerance and expectations.

For example, my company reserves about eight months of expenses. Some people argue that keeping eight months is excessive. After all, that money could be better used growing the business. However, I remember how many companies went out of business during the Great Recession of 2008. An eight-month cash reserve bought me time, options and opportunities.

How do you build a reserve?

Building a reserve is simple. However, it takes significant discipline.

Determine the monthly contribution

The first step is determining a percentage of your profits to direct to the reserve account. It should be large enough to build the reserve in a reasonable amount of time. This step temporarily reduces the amount of money you can take out of the business as earnings. You need to determine an amount that is realistic and practical.

Transfer funds to the reserve account

Transfer the reserve funds to a separate account every month. Keep contributing funds to the account until the reserve reaches the desired size. Avoid mixing your reserve funds with your operations funds. Tracking funds can be difficult, and it’s easy to make mistakes. Instead, use a separate savings or checking bank account.

Consider using a different bank

Recent news has reported several potential problems with the banking system. As I write this, three banks have already failed, and there is a short list of banks that could fail soon. I think your money is still safe in the banking system. However, experience has taught me to be cautious. Consider opening your cash reserve account in a different bank than you normally use for operations. This step ensures you always have access to funds in case one bank gets into trouble.

How do you use a reserve?

You should use your cash reserve only when your operations account can’t cover an urgent need. For example, if you need funds to cover payroll, an urgent repair or another essential expense, consider using the cash reserve. Replenish the reserve account to its usual amount as soon as practical. It’s to your advantage to keep the account at its normal amount whenever possible.

Most importantly, resist the temptation to use the account for special projects. Misusing reserve funds is one of the biggest mistakes business owners make. Unfortunately, that mistake leaves your company unprepared for emergencies.

Should you complement your cash reserve with financing?

Some companies combine a cash reserve with a line of credit or similar product. In theory, the line of credit can be tapped for emergencies, enabling you to keep a smaller cash reserve.

When used correctly, this strategy allows you to keep more funds deployed for projects and business expansion. Many large companies follow this strategy. Maintain discipline, however, since using a line of credit to cover part of your reserve can be a double-edged sword. You could accidentally find yourself overleveraged and with minimal reserves. Or worse, you could lose the line of credit and end up with no reserve funds.


Marco Terry

Marco Terry

Marco Terry is managing director of Commercial Capital LLC, a factoring company and provider of invoice financing to companies in the glass industry. He can be reached at 877/300-3258.