Businesses must be prepared for the unexpected. That is where a cash reserve fund comes in. Setting some money aside every month equips you to handle downturns in the market, large purchases, or critical business pivots that set you up for future success.
What are cash reserves and why do you need them?
Cash reserves refer to the liquid capital businesses and other bodies keep on hand in the event of a need for a quick, large purchase, especially in the event of an emergency. Cash reserves can either be money you have purposely set aside in an emergency fund, or they can be the money you have leftover once you have paid all your normal operating expenses and even unexpected expenses.
Establishing a cash reserve account is about more than simply having some excess cash handy. Businesses must frequently navigate changes and crises, and as the COVID-19 pandemic demonstrated, these can be sudden, unexpected and highly disruptive. You must be prepared if there is a sudden drop in sales and revenue dries up. A healthy reserve cash flow enables businesses to continue paying their expenses and staying in business while they weather a drop in sales.
Benefits of cash reserves
Establishing a cash reserve fund is a critical step for businesses that want to safeguard their long-term growth and stability. Here are some of the top benefits of keeping an emergency money supply:
- Weather a crisis: The main benefit of cash reserves is that it gives your small business a safety net in the event of a significant decrease in revenue due to an unforeseen crisis. Cash reserves give you the space needed to focus on other crisis-management activities, including restructuring your business and identifying new streams of revenue.
- Avoid debt: If revenue takes a tumble, you will have to locate other sources to cover routine operating expenses and stay in business. Without cash reserves, you might have to obtain a loan, line of credit or even use your credit cards. This can cause you to rack up unwanted debt that could make it difficult to access capital again later.
- Make big purchases: Cash reserves also give you access to working capital you can use to fund a large purchase. Whether you are acquiring another company, purchasing an innovative piece of equipment or bringing a new offering to market, cash reserves might give you the cushion to fund those expenses quickly.
Setting up cash reserves
The following steps serve as a guide to getting started creating a cash reserves fund:
1. Aim to build a cash buffer
Businesses often fail because they run out of capital. When setting up a cash reserve account, you should consider how much you might need to weather any ups and downs you encounter when running your small business. A general rule of thumb is to have 3-6 months’ worth of operating expenses saved in your cash reserves fund.
Your cash buffer should not be too large, however. Storing money away for a rainy day is proactive and prudent, but too much and you might not be investing enough in the current growth and performance strategy of your business.
2. Free up cash from your inventory
Unsold inventory is basically cash you cannot access. To maintain a healthy supply of cash and avoid tying too much in inventory, aim to lower your minimum stock levels and try instituting a just-in-time (JIT) policy to avoid large bulk purchases. You might also consider holding a stocktake sale to earn some money back from your unsold inventory.
3. Improve your management of debtors
Ensure that you assess the credit history of all customers prior to extending credit to avoid having too much money tied up in the hands of debtors. You might require credit customers to fill out credit applications that include stricter conditions or enforcing credit limits on every customer.
4. Evaluate your business borrowing
You should not obtain loans just because you qualify for them. Moreover, you might be using loans that do not offer the most favorable terms for your business. Make sure to contact your financial advisor to ensure you are obtaining loans that are best for your circumstances, and work with lenders to restructure existing loans to take advantage of better opportunities.
5. Reduce costs
Reducing overhead costs is one of the most effective ways to put excess cash into your reserves. While you should avoid cutting any costs that might harm your business, it is usually a good idea to identify areas across your business where you can afford to limit spending.
Consider assessing your:
- Communications: Consider reducing your landline usage and adopting internet communication services like video conferencing platforms, which tend to be more cost-efficient and have a wider set of capabilities.
- Technology: Decide whether to upgrade your technology stack to use more efficient solutions and convenient digital apps. Energy-efficient company vehicles, for example, might reduce energy costs substantially over time.
- Energy: Consider instilling energy-saving best practices across your business by encouraging employees to power down all office equipment when not in use and ensure heating and cooling devices are off when you are closed.
6. Sell unused assets
Your business is a growing and changing organism, and that means assets that were critical to your operation yesterday might now be obsolete. Take full stock of all your company’s assets and make a list of the ones that are still used and the ones you can dispose of. There are numerous value-added resellers that will pay you for outdated computer and other tech equipment, which might help you boost your cash flow.
7. Set a cash reserve goal
Assess your business operations and determine how much you need to save every month to deposit to a healthy cash reserve fund. Consider setting up automatic payments to build your fund over time, or shave off a predetermined percentage of your monthly sales and devote that to your fund. Regardless, you should commit yourself to hitting an annual cash reserve goal to stay on track.
At Comerica Bank, we are committed to helping small businesses best prepare for all the obstacles they might face. Reach out to our team to learn more about the strategies you can utilize to build your cash reserve funds.