Like the current Covid environment is showing any sustainable business out there has to have a solid cash flow that holds up even in the tumultuous economic environment.
An integral part of maintaining cash flow is to have enough cash reserves on hand to ensure any surprise liabilities are covered. This cash reserve also helps mitigate the cyclical nature of sales. During a slow month, setting aside business savings ensures the business has enough cash on hand to pay employees and suppliers. The company can weather the storm and then recover when business is good again.
But how much is exactly the right amount to keep in a business savings account?
How Much Should You Save?
The general rule of thumb for any business is that it should have at least six months of runwayin their savings. This means that a business should put away six times the average monthly cash burn rate of a business is the amount to put away in its corporate savings account.
For example, if a business has a total monthly expense of $10,000, then it should have $60,000 sitting in its cash reserve. The above example provides the most straightforward calculation, but businesses generally incur seasonalityin their expenses. This means a company should look at both its most expensive and least expensive months.
Always have cash on hand to cover an expensive month, while also having reserves to cover the other five months. This means if the most expensive month for a business is $30,000, then one should have $30,000 + ($10,000 x 5) = $80,000 in their savings.
Growth and Investment Activities Cash Flow
Cash flow management is much more complex than just calculating straight averages. A business also needs to factor in what stage of growth they are in, and their likely cash burn rate each month.
For example, a start-up will be looking to grow fast and capture market share quickly. This stage of business incurs a lot more expenses. Hoarding cash reserves can strangle how quickly the business can go-to-market and reach sustainable levels. As a result, a start-up needs to aim for far fewer cash reserves at the start while they invest heavily in growth for improved cash flow down the line.
Conversely, a well-established business that has operated for five to six years is now at a stage where having significant cash reserves can allow them to weather out any seasonality, and burn cash for investments to acquire or beat out new entrants.
How to Build a Cash Reserve
Building a cash reserve means a business needs to have great cash flow management practices in place. Yet many businesses (especially small corporations and new start-ups) aren’t well versed in cash flow management. In fact, 82% of small businesses fail due to poor cash-flow management.
Cash flow management is necessary to build an effective nest-egg that keeps a business afloat even during large cash burning periods.
Ensure the business performs accurate financial budgeting and managing expenses to line up with these budgets. Obtain a clear picture of cash flow by building cash flow statements that outlines cash inflows and outflows on a monthly basis, and consider using cash flow management services. Having a clear picture of company cash flow can ensure more accurate estimates of their monthly costs. In turn, a company can start building a consistent pool of cash that can be kept in a savings account.
Corporate cash reserve funds shouldn’t be touched at all or left to accrue interest. When estimating how much needs to be moved into a savings account, be aware of any tax obligations and factor these in when determining the amount.
Benefits of Corporate Savings Accounts
Beyond just prudent and effective cash flow management that protects a business from downturns and burning cash too quickly,corporate cash reserves deliver other benefits:
Liquid cash can serve as a powerful weapon for any business. If an unexpected investor enters the market and is poised to steal share, or looks like an attractive investment or acquisition that can skyrocket good cash flow, having cash on hand ensures that these strategic business decisions can be executed rapidly.
The government insures nearly all business cash reserves accounts for up to a certain amount. This amount varies from $250,000 to $500,000 depending on the location of the bank. Most banks will not have protections in place for regular chequing accounts in case of a breach or unexpected event, but nearly all have protections in place to ensure that any amount kept in savings is insured.
Improved credit ratings
Money in a corporate savings account can also help boost the credit rating of a business. Banks love companies that aren’t over-leveraged and will be more comfortable handing out loans if they know the business has cash sitting in a savings account to pay back any liabilities.
Businesses often forget to keep cash reserves in order to fulfill any tax obligationsthey still have at the end of the year. This is especially true for younger companies without any dedicated finance teams or staff in place to keep tabs on these potential liabilities. As a result, having a savings account ensures any money placed in the account can hedge bets when tax season rolls around.
Any money in a savings account gathers interest. This interest isn’t significant, but it can help beat out inflation at a minimum. There are many banks that will also offer high-interest savings accounts, which may be beneficial. For example, a company with $500,000 in cash reserves in an account accruing 2.5% annual interest - that’s $12,500 of cash yearly just from interest!
Having a business savings account to optimize cash reserves is important for a myriad of reasons. It will help a business tackle unforeseen events requiring sudden cash burning that could potentially bankrupt the business. One can even take the principles of saving cash for the company and apply it personally. Happy saving!