This is a guest post by Float, for more information visit floatapp.com
A rainy day fund can be a lifesaver for your business. Having a pot of instantly available cash to draw on safeguards you from any nasty surprises such as a larger than expected tax bill, a change in the market that affects sales or a late payment that threatens to cripple your operations. But how much of a financial safety net should you have?
You may have heard that having enough cash to cover at least 3 months operating expenses is a good place to start, but every business – and every business owner – is different.
So without further ado, here is how to build your cash cushion in 3 simple steps.
When deciding how much cash to set aside for a rainy day you should consult your business objectives.
For example, if you are a seasonal business you may need to adjust your emergency fund for low seasons to see you through or to cover all the expenses that need to be payed in the high season. You should use your historical cash flow statements to identify how much money you need to have available at different points of the year.
If you are a high growth business you may need to run close to the wire so you are maxing out your total cash available for reinvestment which could leave you with less cash on hand.
Your accountant will be able to advise on the cash reserve that is optimal for your business.
Now you should do a thorough review of all your expenses (sometimes referred to as your monthly cash burn). You want to make sure you can meet your obligations such as rent, bills and payroll.
To do this start by totalling all of your operating costs for the month then multiplying this by the number of months you want to cover (3, 6, 12 etc). You’re buying yourself peace of mind, knowing that you can weather any temporary downturn in trading conditions.
Again, it’s important to remember the larger your reserves the less money you will have to grow your business or to take as drawings or to invest in your pension. So while it may seem tempting to keep a year’s cash on hand, such a conservative approach may prevent you from achieving your full potential.
Again, talk to your accountant! They will help you identify your monthly costs so you know how much cash you should keep on hand. And they may also help you set up a cost control system to make sure your operating expenses are always as efficient as possible.
Start saving cash. An easy way to do this is to divert a portion of your profits to a separate bank account that can be accessed easily. Keep doing this until you have your cash cushion. Your accountant will be able to advise how much to save each month.
Alternatively, here are a few other ways to ensure you always have enough cash available:
- Reduce your inventory, unsold stock ties up cash
- Speed up collections, offer incentives to customer who pay early and get tough with those who pay late
- Negotiate an overdraft or line of credit
The main takeaways here are:
- a cash cushion will help protect your business from unexpected changes
- the actual cash amount you need will vary from business to business
- your accountant is a great person to consult to help you get into the most optimal cash position as quickly and painlessly as possible