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Financial literacy
11 min

How much cash should a business have on hand?

How much cash should a business have on hand to stay financially secure? Explore the answer, plus strategies for effective cash management.

Published at
A coffee shop owner setting some cash aside.

There’s no way around it: Cash is the fuel that keeps any business running. Without it, you won’t be able to pay for supplies, rent, or labor. In times of crisis, cash reserves can even mean the difference between pulling through and shutting down. But the average small business only has enough cash to survive for about a month without income, which isn’t ideal.

So how much money should a small business have in the bank at any given time? Well, there’s no one size fits all answer. It varies by business stage, industry, and the volume of your revenue and expenses.

In this article, we’ll help you figure out how much cash you need, and offer some efficient ways to increase your reserves.

Why cash reserves are so important for small businesses

For a business, especially a smaller one, having cash reserves is like having insurance without buying a policy. It means that even when times are rough—for example, due to illness, economic crisis, a global pandemic, or supply chain issues—you’ll have enough to cover your costs until you get back on your feet.

While a loan can also help with a temporary cash crunch, it can take months to be approved for one, and that could be too late. Plus, you’ll end up paying more in interest rates for this loan, instead of letting your money grow in your account.

Moreover, having some extra cash lying around is not just for emergencies. It’s also good for when an unexpected opportunity comes knocking. The last thing you want to do is say no to big projects or expansion options just because you’re low on cash at the moment.

Wait, are we talking about cash flow?

Not exactly, but the two terms are closely linked. Cash flow refers to the movement of cash in and out of your business. If you’re bringing in more than you’re spending over a set period of time, that means your cash flow is positive, or healthy, which is great.

But just keeping your cash flow positive isn’t always enough. You also need to make sure you have sufficient reserves or buffers. Therefore, this article focuses on money put aside that you’re not using for your day-to-day operations, and so it can be used for unexpected events. This can be a crisis or an opportunity that requires some investment.

Types of cash you can have on hand

Cash on hand doesn’t have to come in the form of actual paper bills. It can also be in:

  • Checking accounts that can be immediately withdrawn
  • Savings accounts that can be withdrawn on short notice
  • Tangible assets that can be liquidated quickly

The only rule is that it can’t be money that is otherwise tied down. For example, the minimal sum that needs to be in your bank account to keep it active cannot be counted towards your cash reserves because you can’t access it.

How much money should a business save?

There is no magic answer to how much cash you actually need to put aside for your business. There’s also no average cash on hand for small businesses. The exact sum will depend on your industry, business situation, and how much money you can realistically save.

The common wisdom is to set aside the equivalent of three to six months of operating costs. To figure out how much that is, refer to your balance sheets, expense reports, and other financial statements from the past year. Calculate the average amount you spend in a month, then multiply it by three to six.

How to calculate your operating costs

There are several aspects to operating costs. Check your statements to get the full picture.

  • See how much money you spent over the past year on recurring expenses like rent, salaries, utilities, and taxes.
  • Also check how much you spent on varying costs such as equipment, repairs, marketing, raw materials.
  • List down how much unexpected expenses cost.

Then, add up all of the expenses your business had in the previous year and divide the sum by 12. This will give you the monthly average cost of operations.

Multiply that sum by three to get the three months savings amount you want to aim for, or multiply by six to aim for a six month reserve. 

Be conservative in your calculations. It’s better to have a slightly larger buffer than to be lacking when the need arises.

Warning signs of cash shortages and solutions

While there’s no universal answer to how much cash should a company have on hand, there are clear warning signs to notice when it comes to upcoming cash shortages.Illustration titled “Early warning signs of cash shortages.” It shows four cartoon-like figures representing: too much inventory (boxes on a dolly), constant late payments (person checking watch), reliance on one or two large customers (handshake between two figures), and slower growth rate (figure pointing at a downward-sloping bar chart).

Recognize early warning signs and take action

Some of the key signs you might be facing a cash shortage soon include:

  • Too much inventory: If you have more inventory on hand than you’re usually able to sell, your revenue might end up being smaller than expected. It’s time to get creative about getting it sold and analyzing what drives more purchases now.
  • Constant late payments: If customers constantly pay you late, or you regularly  run into non-payers, there might be an issue with your chosen customer base or the written agreements you have with them.
  • Reliance on one or two large customers: It’s tough to say no to large accounts as a small business, and you don’t necessarily need to, but most customers don’t stay forever. That means there will come a time when you have a big financial hole to fill. Do your best to keep marketing even when you’re fully booked.
  • Slower growth rate: Maybe you’re selling well and living comfortably, but your growth rate has slowed down. Maybe you’re used to growing 10-20% a year, and suddenly you’re only growing by 15 or 5%. It’s worth it to analyze what’s happening and work toward healthier growth. Minimize expenses where you can to give yourself more financial bandwidth or the option to invest in strategic consulting or opportunities.

 

Steps to take when cash is tight

This might be a scary situation, but you can turn it around with these action steps.

  • Assess inventory and product needs.
  • Analyze which expenses you can reduce or let go of.
  • Encourage faster payments and improve invoicing efficiency.
  • Target a more affluent customer base.
  • Prioritize your time for revenue generating activities.

Exploring financing options

Everyone has times in their lives or businesses when they need help. Sometimes that help is financial. The following are some choices to explore. But even when times are rough, be mindful of the risk you take and consider consulting with a professional before applying for financing options.

  • Bank loans: This is the most common option. It can be easy to get funded quickly if you’re eligible, but you need established revenue for that. These loans usually come with high interest rates.
  • SBA (US small business administration) loans: While the loans are granted by the SBA, lenders are often banks. It can be more challenging to qualify here. If you do, you can get low interest rates and often better terms than regular bank loans.
  • Microloans: That’s the option to borrow a small amount, from a few hundred dollars to $50,000. Payment terms and interest rates might vary widely depending on who you borrow from.
  • Small business grants: While it might not be easy to find or prove eligibility for federal, state and private grants, they are available for small businesses across the country. This is, of course, better than loans, since you don’t need to pay the money back.
  • Crowdfunding: Any business can sign up to an online crowdfunding platform and ask people to transfer them money. Usually, you explain the challenge you’re facing or the product you’re developing, and ask people to make a payment. It’s recommended to offer multiple payment tiers. The more someone pays, the bigger what they receive in return is (multiple product versions, product signed by a celebrity, invitation to an exclusive event only for those who paid over a certain amount, etc).

How to increase your cash reserves

Now that you know how much cash you need, there are several things you can do to stuff your cash cushion.

Encourage faster payments

We know what you’re thinking: You’re lucky if your customers pay you on time, so how can you ask them to pay even sooner? Well, you won’t really need to ask if you provide them with the right incentives.

For example, you can offer early bird discounts to loyal customers willing to pay sooner for large orders. A 5% discount can go a long way to accommodate your customer and save them cash while giving you an always welcome infusion.

Another way to encourage earlier payments is to make it easier for customers to pay you. While you may be used to checks, they are among the slowest and least efficient ways to get paid. They’re also a hassle for both the recipient—who needs to wait for them to arrive, go through the reconciliation process, and walk to the bank to deposit them—and for the customers who need to manually write them, handle postage, and worry whether they will arrive on time.

Using an online accounts receivable (AR) platform like Melio, you can give your customers better choices without affecting how you get your money. They can choose to pay via bank transfer, debit card, or even credit card, according to what works best for their business and existing workflows. You will get the money directly to your account, via ACH bank transfer.

Just by offering better choices and an easy payment process, which can be completed from anywhere, you are making it more likely for customers to pay sooner.

Improve cash flow health

While maintaining cash flow health isn’t the same as having cash on hand, it’s definitely a good place to start.

Using an online tool to manage accounts payable (AP) and AR is a great way to improve cash flow. Digital payments provide greater visibility and control over every payment coming in and out of your account, so there’s a better chance you won’t spend more than you can afford.

Another way to improve oversight is to use apps to predict your cash flow. These tools allow you to see what impact each payment you make has on your cash flow, and simulate the effect of various payment terms and methods.

Make sure you’re not overspending

While the old saying is true—you need to spend money to make money—you still need to examine what you’re spending it on and where you can save.

A few ideas to help you save money:

  • Check if you’re eligible for any discounts or special offers from your vendors. Maybe you’re spending a large enough amount to deserve a bulk discount, or you’re paying early. Or maybe they just value your relationship with them so much that they’re willing to accommodate you.
  • Periodically examine your subscriptions and purchases to make sure you’re not paying for something you don’t need. This can be anything from a coffee bean subscription to a design software you only used once to create a pamphlet, but continue to pay for annually.
  • Eliminate unnecessary bank transfer fees by switching to an online business payment platform, like Melio, that offers free ACH bank transfers.

Let your money work for you

Having more money in your checking account is great, but if you can, avoid letting your money just lie around, especially with the fear of inflation looming. Instead, deposit some of your cash into a high-interest saving account so it continues to grow and does not depreciate in value.

Before you do that, however, check the terms of the account to make sure the funds can be liquidated quickly if you need them.

 

Cash is always king

Even when things are going well, you shouldn’t be tempted to neglect your cash reserves. Sign up for Melio to keep a closer eye on money coming in and out of your account, and ensure your cash is always flowing in the right direction.

*This blog post is intended for informational purposes only and is not intended as financial advice.
**Melio does not provide legal, tax or accounting advice, and you should consult with a professional advisor before making any financial decisions.

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