How Much Cash on Hand Should Your Small Business Have?

Great question! Experts agree that businesses should keep cash that covers three-to-six-months’ worth of business expenses. Sounds simple? Not really. Calculating for this amount greatly depends on a lot more factors. Some of these are business seasonality, strategic plans, or special scenarios like a pandemic. Read on below for a straightforward guide to help you zero in on how much cash on hand your business should have.

Why Cash?

Liquidity refers to the ability of a company to pay its debts and is one of the key indicators of business success. Meanwhile, cash is the most accepted payment method in the world. It can easily be used to acquire other assets or like mentioned, pay liabilities. Hence, it is considered the most liquid asset.

Despite this, it is usually unwise for a business to have too much cash. Instead of letting it sit, it is better to use available capital to expand operations, acquire equipment, or market your brand.

So, how much cash does your company need to keep? Short answer: it depends.

Read through the seven steps below to help accurately identify the amount of cash that is best for your small business.

1. Determine Overhead Expenses

Start by revisiting your financial statements from last year. These should give you a better idea of your costs. Overhead expenses may include the following:

• Rent (Office space, Warehouse)
• Utilities (Electricity, Water, Phone, Internet)

If past-year statements are unavailable, feel free to project from your more recent expenditures.

2. Specify Operating Expenses

Next, identify your operating costs. These are expenses directly attributed to your business’ products and/or services. These include but are not limited to:

• Cost of Goods Sold
• Salaries and Wages

3. Calculate Monthly Average 

Once you’ve successfully identified your previous overhead and operating expenses, go ahead and compute for your monthly costs. Simply divide the total amount by 12 to get the average.

Now the easy part is done, let us move over to adjusting your average monthly expenses based on your business’ circumstances.

4. Determine Seasonality

Does your business operations fluctuate throughout the year? For example, hotels consider summer and year-end as their peak seasons. During these periods, both profits and operating expenses grow. 

Identify your company’s seasonalities and adjust your average expenses accordingly. 

5. Account for Rapid Growth

Are you planning on scaling your business soon? Rapid growth signifies more expenses for the business. You will need to hire more staff, manufacture more products, or even move to a larger office space. 

Based on your recent strategic planning session, identify your expected growth.

6. Special Circumstances

Finally, consider special scenarios like loss of your biggest customer or your best salesperson or even a natural calamity. A very timely example is this pandemic, which as of writing, shut down more than 2,000 businesses in the country. 

Your business should have sufficient funds to cover your operations despite these kinds of occurrences. Aside from having a cash safety net, here are more ways to help your small business endure the tides. 

7. Multiply By Number of Months

Based on the guides above, you should be able to find a comfortable number of months of operations that your cash on hand can cover. Whether that is three months, six months, or more greatly depends on your business’ situation.

Additionally, if you are not comfortable sitting on too much cash on hand, consider investing in near-cash assets like short-term bonds or money market instruments. These facilities generate a bit more interest income compared to traditional bank setups, yet still give easy access to your funds when needed.

Managing your cash wisely will surely make your books look better for potential investors. But more importantly, handling your assets well can make or break your small business.

Find out how MPM can help your small business with Accounting and Tax Preparations by clicking the button below.