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Cash Reserve: Its Importance and Why Your Small Business Needs One

By May 30, 2019 No Comments

Longstanding, successful businesseslarge or smallhave one thing in common: a cash reserve. From keeping your small business running smoothly despite slow paying clients to paying your web designers and other suppliers, a cash reserve can “smooth out” any bumps on the road on your way to success. Of course, having a cash reserve can also allow you to take on new growth opportunities as well as protect your company through an unexpected downturn. 

If you already have a cash reserve, then great! But if you don’t or have no clue what it’s used for, then it’s crucial to start one immediately.

To help make cash reserve easier to understand, here’s what your thought process should look like:

How Much Does My Business or I Spend Each Month?

Before even thinking about building a cash reserve, you need to understand your business’ monthly expenses. Of course, businesses with fairly regular expenses throughout the year versus seasonal businesses (who have most of their expenses concentrated in a few months of the year) must use a different approach.

If you use an accounting software (which, you should!), review your cash flow statements (also known as Statement of Cash Flows) for the past six months. Look at how much you are spending each month. If expenses are more or less the same, average all the numbers to get your average monthly expenses.

How to do it in Kashoo: From your Work Space Dashboard, you can view a variety of financial statements under “Reports,” which are useful when consolidating both cash inflows and outflows for your cash flow statement. Your statement should embody the following information:

*Image taken from Corporate Finance Institute (CFI)

If you are looking for accounts like Accounts Payable and Accounts Receivable, inventory, wages payable, and income taxes payable, click Income Statement under “Reports” to gain access to this information. You can also easily export all your earnings to Excel, CSV, HTML, PDF or Google, as well as customize it to This Year, Last Year, or even compare This Year to Last Year’s earnings, among a few others. Easy, right?

How Big Should My Reserve Be?

Although the answer varies from business to businesswith some experts who recommend having three months of expenses to others who recommend six. Your cash reserve should  be enough for you to feel comfortable running your business despite challenges like slow paying clients and a slow season. It’s equally important to note that having a large cash reserve is not meant for every business. In fact, it limits profits and growth for some, as it ties up cash that could actually be used to expand the business.

Calculating My Cash Cushion

Let’s say your small business is pretty steady from year-to-year. In this case, simply multiple the monthly average you calculated in the earlier section by the number of months you want in your reserve. If you chose six months, multiple it by six.

Example: Your average costs are $10,000 a month and you want to maintain a six-month reserve. Multiple $10,000 x 6 months to get a total cash reserve of $60,000.

Building My Cash Reserve: Getting Started

Getting started on your cash reserve is easy. It’s saying goodbye to available funds that makes it difficult. Start by determining the portion of your profits that will go into your reserve. Simply transfer those funds to a separate bank account and build the reserve until your amount (i.e. $60,000) is reached. A good rule of thumb is to always keep these funds separateout of sight, out of mind, right?

Building a cash reserve is crucial, but can also be difficult if you’re not tracking your income and expenses the right (and smart) way. Looking to instantly and easily gather your financial data in one place? Explore Kashoo’s 14-day free trial to see how our accounting software can help you track your cash inflows and outflows and relative information in a unified work space!