Running a business is a lot like driving a car. Most of the time, everything runs smoothly but what happens when you encounter a flat tyre in the wee hours? If you have never learnt (or heard of) how to change a tyre or don’t know who to contact in the middle of the night, even a minor issue can quickly turn into a major problem. For businesses, the “spare tyre” that helps you navigate these bumps is your cash reserve.
What is a Cash Reserve?
Think of a cash reserve as your business’s emergency fund. It’s money you set aside specifically for unexpected expenses or tough times. Just like how you’d set aside some money at home for emergencies—like your fridge breaking down or a leaky ceiling - a cash reserve is there to keep your business running when things don’t go as planned and things do often don’t go as planned.
Why Your Business Needs a Financial Umbrella
- Shielding Against Cash Flow Rainstorms: When I was running my event agency, all outdoor events were always planned with a wet weather contingency plan in case it rains, even when the weather is forecasted to be sunny because you just can never know. If it suddenly starts to rain, our event can still run according to plan. Similarly, in business, cash flow disruptions—like delayed payments from customers or a sudden drop in sales—are like unexpected rainstorms. A cash reserve acts as your financial umbrella, keeping your business dry and stable until the storm passes.
- Covering Surprise Expenses: We’ve all had those moments when an unexpected bill arrives—like your car breaking down or needing to replace your fridge. These surprises can be stressful, but having a little money set aside makes them manageable. For your business, surprise expenses like equipment repairs or legal fees can come out of nowhere. A cash reserve is there to handle these costs without throwing your budget off track.
- Navigating Economic Storms: My meeting space business was one of the hardest hit industries during the pandemic and it taught us a lesson the hard way - every business must be prepared for anything. Imagine running a meeting space where you had to endure 2 months of lock down and 2 years of working-from-home where almost no business is having physical meeting. The economy can be unpredictable, with ups and downs that can impact our businesses. A cash reserve helps us stay afloat during economic downturns, ensuring we have the resources to keep moving forward, even when times are tough.
- Seizing Opportunities: In business, opportunities like purchasing discounted inventory or hiring a talented employee—can pop up unexpectedly. Even a simple action like buying a SaaS product on a yearly subscription instead of a monthly one requires cash. A cash reserve gives us the flexibility to seize these chances without scrambling for funds.
- Keeping Our Business Creditworthy: Imagine you’re borrowing your friend’s Mercedes Benz. If they know you’re responsible and will return it safely, they’ll lend it to you without a second thought. Similarly, lenders and investors feel more confident in businesses that show financial responsibility. A healthy cash reserve signals that your business is well-prepared and ready to seize growth opportunities, making it easier to get loans or attract investors when needed.
What is the Magic Number to Set Aside?
The amount of cash reserve you need is different for every business. A good rule of thumb is to have enough to cover 3-6 months of operating expenses. Here’s a guide to figure out what’s right for you:
- Calculate Your Monthly Expenses: List out your business’s monthly operating expenses. This includes rent, utilities, payroll, and any other regular bills. The best way to do this is to look at every line item in your bank statement to make sure that all business expenses are accounted for. For annual business expense, divide it by 12 to get an accurate estimate.
- Consider Your Business’s Risks: Every business has its own risks. For example, a restaurant may need more reserve cash to handle the ups and downs of customer traffic, while a consulting firm with stable contracts may need less. Think about what could go wrong in your business and how much you’d need to handle it. Always go for worse case scenarios like 0 sales like what happened for some restaurants during the pandamic.
- Plan for Growth: If you’re planning to expand your business or take on new projects, you will need a larger reserve. It’s like saving up for a home renovation—you need more money set aside to cover extra costs and unexpected delays.
Building Your Business’s Reserve Fund
Creating a cash reserve for your business takes time and discipline. Here are some simple steps to get started:
- Start Small, But Start Now: Even small amounts add up. Set aside a little bit from your monthly profits, just like you would save spare change in a jar. The important thing is to start, no matter how small.
- Automate Your Savings: Set up a standing instruction to a separate bank account for your cash reserve. This way, saving becomes a habit, and you won’t be tempted to spend the money elsewhere – what you don’t see, you don’t spend.
- Check In Regularly: Review your business cash reserve every 6-12 months. If your business is growing fast, you need more regular check ins. Make sure it’s growing and still meeting your business’s needs as they change over time.
- Keep It Out of Sight but not Out of Reach: Your cash reserve should be easy to access in an emergency but not so easy that you’re tempted to use it for everyday expenses. Avoid locking your cash reserves in stocks or bonds even if they are safe investments – it is called CASH reserve for a reason.
- Refill After Use: If you need to dip into your reserve, refill it as soon as possible. It’s like restocking your pantry weekly - if you don’t, you’ll be caught empty-handed next time you need something.
Having a cash reserve is knowing you have a backup plan in place. It helps you sleep better at night, knowing you’re prepared for whatever comes your way. There was a time in the early days of entrepreneurship where I spent so much time calculating if I have enough funds every time a new opportunity arises. Instead of panicking or making rushed decisions like I did, having a cash reserve can help you handle unexpected challenges with a cool head and a clear plan.
A cash reserve is your business’s safety net, insurance policy, and peace of mind rolled into one. So, start building your cash reserve today, and give your business the protection it deserves to weather any storm.