Do You Know How Much Cash Your Business Needs To Survive?
Every business needs cash in order to operate successfully and to and enable it to grow. As a business owner this should be something you should know as without cash your business may not survive. Although many people think the answer is linked solely to operating expenses, this isn’t the case.
There are several factors that may determine how much cash each business needs to have on hand. Usually we advise somewhere between 3-6 months of operating expenses as an average baseline to start with however, there’s more to it than that.
Some factors that determine how much cash your business needs include:
Where your income is derived from is an important factor. If the source of your income is not diversified—meaning, if the majority of your income comes from one or two main clients—you will need to have a larger portion of cash on hand. This will reduce your risk should your main client decide to leave you. You may suddenly find yourself at risk and with significantly less money coming into your business.
If your income is diversified, you’ll be better place to withstand losing a client, and therefore require less cash. So, if the majority of your income comes from one source, then you will need to be prepared to have little income should you lose that client and allow the time to find a new source of income or client.
Likewise if your business has investors, they could request their money back at any point. You will need to cover that as well.
Typically businesses have fixed overheads as well as variable expenses which particularly relate to the cost of goods sold. You need to know how each of these affect you over a few months so you can be prepared to cover these.
Review your financial statements for a period of at least six months, and make sure you account for both the busy and slow seasons. See where your money is spent and how much you need on average to cover those expenditures.
Liquidity means how easily your assets can be turned into cash. Stocks and bonds can easily be converted to cash, whereas property and equipment often take time to sell and are therefore less liquid.
The more liquid your assets are, the less cash you’ll need. If you don’t have a lot of liquid assets, you will require more cash to be accessible.
Your spending situation is based on how much of your expenditure is mandatory and how much is discretionary—meaning, you can operate without those expenses. If you have a high proportion of mandatory expenses, you’ll need cash to cover these should things become tough.
Discretionary expenses can be cut without significantly affecting business, saving you money or freeing it up for mandatory expenses. If you spend $10,000 a month on employee meals, or taking clients out you can easily save that money by avoiding these situations for a little while until you get back on track.
The more rigid your spending situation is, the more cash you’ll need on hand.
Another important factor is opportunity cost. Money covers emergencies and downtimes but, keeping too much money in the bank can also mean missing out on investment opportunities that could help build your wealth and to quickly convert to cash. This would be a time to engage with your financial expert so they can help you understand your opportunity cost and whether you need more or less cash.