We frequently write about the importance of cash flow and how devastating it can be to your business if you cannot cover vital costs such as payroll. If it is possible, it helps to have cash available in the form of a cash reserve so that you can cover essential expenses in a cash flow crunch. Let’s consider how companies maintain a cash reserve, and look at how to decide upon ideal reserve amount for your business.
Building up a business savings account is a great way of making sure you have money when you face a commercial finance challenge. This is not always easy, as few companies have the luxury of a large cash surplus from sales after all the bills have been paid. A loan or line of credit can be used as a cash reserve. Many companies have turned to banks to receive loans or lines of credit for this very reason. The ideal amount held in reserve varies from business to business. Think about the following:
- Variable costs – this amount can fluctuate from month to month, and these costs are related to sales and production. The more you sell, the more you will have to spend on production, and vice versa. Does your business provide a product or service? If you make product, you obviously have production costs to consider. You need enough in reserve to cover materials, as well as the cost of keeping a production plant in operation. If you are a service provider, those costs could be considerably less.
- Payroll costs – payroll is one of the most vital costs to be covered, as unhappy, unpaid employees will soon start looking for alternative employment.
- Fixed costs – the regular expenses to be covered on a monthly basis, not related to producing goods or services.
Once you look at all of these operating costs, taking into account seasonal fluctuations, and sales peaks, you will have a clear idea of how much money you would need to source to stay in business while cash flow is compromised. An accurate cash flow forecast will make all the difference. Hopefully there will not be a significant interruption in cash flow, but anticipating how long you foresee any potential shortage lasting will help you decide how much you need in reserve.
The question then remains, where else can companies go to obtain the funds that provide a healthy cash reserve? There are many options available as well as those mentioned above, such as credit cards, angel investors, or personal savings to name but a few. If cash reserves are hard to come by, but you have a healthy amount of accounts receivable, you may want to look at invoice factoring. Factoring your invoices offers a financial solution that can answer the cash flow dilemma. However, good business forecasting, and judicious spending can still make difference between success and failure.