I talk with small business owners who are struggling during this pandemic. One of the questions I ask is "Do you have enough in cash reserves to cover expenses for the next 30-90 days?" Why? These reserves are crucial to help you pay vendors and employees during a financial crisis. Here’s how to figure out how much cash reserves your business needs for the next three months.
1. What Are Your Monthly Expenditures?
Before you begin building cash reserves, you may want to figure out your monthly business expenses. Depending on the industry, some businesses have fixed costs with little variance, while others have costs concentrated within a short period. Review your cash flow statements over the last six months.
If your expenses are similar from month-to-month, calculate the average for these costs. If you have concentrated expenditures, select a period that includes a month of your highest business expenses. Then exclude the highest month when you calculate your average for the period. This information is useful for determining how large a cash reserve you need.
2. What Size Cash Reserve Do You Need?
The amount in cash reserves you should have will depend on your business and comfort level. Many experts recommend a minimum of three months of expenses. Your CPA can help you determine the exact amount that your business needs. Large cash reserves may prove detrimental by tying up the amount of cash available for business growth.
3. How to Calculate Your Cash Reserves
If you have consistent business costs, multiply your average costs by how many months of cash reserves you desire to maintain. A business that has $20,000 in average costs should have $60,000 in cash reserves for three months. You may want to save enough to cover your highest month of expenses and some regular months for seasonal businesses. If your business's highest month is $150,000 and your average month equals $20,000, multiply your average month by two, then add the highest monthly cost. This gives you a total of $190,000 for three months of cash reserves.
4. Ways to Build Cash Reserves
One of the best ways to build cash reserves is to set aside a portion of your profits. You can also use financing to cover business expenses while you set aside your profits. You can acquire financing through a Small Business Administration loan, bank line of credit, or invoice factoring. Consult with your CPA to determine what solution is best for your business.
5. Professional Solutions for Building Cash Reserves
Whether your business is starting out or trying to expand, having the right amount in cash reserves is crucial for its success. Emergency funding takes discipline and the right strategy to make sure you survive financial storms.
If you lack sufficient cash reserves for your business, contact Myrick CPA to learn more about our cash management services. As planners, we are here to assist you in navigating simple solutions.
Stay safe, stay well, and stay tuned,
Charles and the Myrick CPA Team
Charles P Myrick CPA, Washington DC tax preparation firm, specializes in accounting services for small business start ups and entrepreneurs. If you are a new entrepreneur, give us a call. We invite you to learn more about the small business accounting services that are available: (202) 789-8898.