When starting your small business, you’ve budgeted for your location, equipment, inventory, working capital and more. But did you factor in the foundations of a cash reserve?
A cash reserve is a crucial aspect of business that entrepreneurs tend to forget. Also referred to as a “rainy day fund,” this pool of cash can be critical in carrying your business through difficult financial periods.
What is a cash reserve and why is it important?
A cash reserve is a sum of cash that is set aside to cover operating expenses during times of economic hardship or to overcome cash flow hurdles. Essentially, it’s your business’s emergency fund. Most small businesses would do well to keep a cash reserve that could cover three to six months of business expenses, but every business is different.
Cash reserves are extremely important for keeping businesses stable. Lots of things can cause financial trouble for small businesses that are still growing. Clients might pay invoices late, interrupting your expected cash flow. Business might slow down for a while, leaving you with smaller margins. Or, you might have an unexpected expense that puts you in a bit of a bind.
Having a cash reserve available when these things occur allows you to continue operating your business as usual without experiencing significant financial hardship. You and your employees can still be paid, you can meet debt payments on time and your overall risk is minimized.
Building your business’s cash reserve
To start building your business’s cash reserve, you’ll want to first examine how much money you spend in a given month. For most businesses, this can be done by taking a look at cash flow statements from the past six months. How much money do you spend to keep the business running?
Find the average of your monthly business expenses, then multiple that number by the number of months you want to have covered in your cash reserve.
Start a separate business bank account, so you can keep your reserve cash separate and aren’t tempted to dip into it. Then, determine how much of your monthly profits you can reasonably allocate toward the reserve. Keep saving until you reach your reserve goal. If you take money out of the reserve, aim to replenish it as quickly as possible.
Many business owners are wary about putting profits into a cash reserve because their ability to grow the business might be hampered without the extra cash. The trade-off between growth and cash flow security should be made carefully. However, there is another option.
Financing your business with a cash injection can give you a boost that lets you build your cash reserve and grow faster. Microloans from the SBA can help you cover operating expenses as you pursue growth while still freeing up cash to build your reserve. Another option is to roll over a 401(k) from a previous employer through a rollover as business startup (ROBS) to provide your business with debt-free financing.
Are you prepared for a rainy day?
The COVID-19 pandemic revealed that all too many businesses aren’t prepared for a sudden and extended drop in profits. Sadly, many businesses were forced to close because they didn’t have money saved for a “rainy day.” Building and maintaining a cash reserve for your small business is the best way you can prepare for the worst and keep your business afloat.
If you’re looking for ways to finance your startup or growing business, Tenet Financial Group is here to help. Our financing products help small business owners capitalize their ventures and prepare them for growth. Contact us today to learn more.