Most people have heard the personal finance adage that they should have cash equal to 6 months of expenses on hand, in case they lose their job or have an emergency expense. But should businesses? And is it realistic or wise to have that much capital sitting around?
The short answers: Yes, and yes. How much you need will depend a lot on your business and cash flow, so talk with a banker or business advisor who can draw on experience working with many businesses like yours.
Rule of thumb is three to six months of expenses…
Factor in your size, cash flow and liabilities. Cash reserves aren’t one-size-fits-all. To get to your best number, talk to an advisor. If you are the only employee, work from home, don’t need raw materials and have personal reserves, the amount you need is less. If you need to pay salaries and rent, or build inventory ahead of a seasonal rush, you may want more.
… but not all expenses are equal
Split ongoing monthly expenses from production costs. Salaries, insurance, rent and regular ongoing expenses need to be covered whether it’s a slow month or busy month. But for manufacturers or builders, raw material costs will be higher when you are busy, since you have more stuff to make.
Don’t guess; dig into your financial records
Records aren’t just for taxes – they also help you make strategic decisions. You can find patterns in your financial statements, old orders and payroll records. Math not your strong suit? Bring in an accountant or banker to help sort it out. These records will give you baselines, and those baselines will help determine a smart reserve.
Create a plan to get your reserve goal
Building a reserve can be daunting. Just start. If you wait until you have a big surplus to establish your reserve, it might never happen. Start now if you don’t have one. Once again, an advisor can help you create a plan to build your reserve gradually, so you have a clear goal and manageable steps.
Lines of credit may provide flexibility when used right
Debt shouldn’t be your primary reserve, but it can be a bridge. Unexpected things happen. Sometimes, even with a reserve, you might need a loan to carry you through. Setting up credit to tap into when needed on short notice is a smart move. Get it from a bank that knows you and your business personally – you’re likely to get better terms.
One other thing: Reserves don’t need to be stuffed under a mattress. Depending on the reserve size and how quickly you may need to access it, some might be held in higher interest earning but still safe and liquid products. If it seems more complicated for a business than a person – that’s because it is.
Want to learn more? Come talk with an Alerus business advisor or visit
alerus.com
