Preparing for the Unexpected: The Importance of Cash ReservesPosted on September 28th, 2020
One of the many lessons that this year has taught us is to expect the unexpected. For small business owners, that means being prepared for any number of potential challenges. Who could have foreseen the ways in which a pandemic would change how we do business, or predict how those changes will continue to shape the future?
In uncertain times like these, the one thing we can be sure of is that challenges will arise. So will opportunities! When they do, we need to be prepared. But how can we prepare for the unexpected?
In the face of an uncertain future, the single best way to protect your business is to set aside sufficient cash reserves. With the right amount of savings, your business can adapt, invest, react, or cushion itself when an opportunity or a challenge arises. In fact, the ability to do so can make or break a business. As fears of a looming recession persist, now is the time to ensure you’re prepared.
Why Keep Cash Reserves?
While it may seem obvious that having enough money in the bank to respond to unexpected challenges or opportunities is important, the majority of small business owners don’t keep enough cash in reserve to provide the flexibility they need. According to the 2020 Small Business Credit Survey conducted by the Federal Reserve Banks (prior to the Coronavirus pandemic), “If faced with a two-month revenue loss, 86% of firms would need to take some action to supplement funding or cut expenses.” While this in itself isn’t surprising, the actions respondents indicated they would take might be.
47% of firms reported that their first course of action would be to dip into the owner’s personal funds, while 17% said they would simply have to close if faced with a two-month revenue loss. Meanwhile, 56% of small business owners polled said that they had “used funds from their personal savings, friends, or family within the last five years to support their business.” This is a burden owners shouldn’t have to bear, and a great argument in favor of cash reserves.
But having substantial cash reserves isn’t just about keeping your business afloat through a slow season or financial challenge – it’s also about creating an environment in which you can respond to new opportunities. Whether a new partnership, a product line or service expansion, a technology upgrade, or another opportunity, cash reserves give us the confidence and ability to embrace changes that grow our business.
How Much is Enough?
Among small business financial advisors, it’s common practice to suggest that cash reserves should cover between four to six months of operating expenses. That usually provides enough of a cushion to cover an unexpected drop in revenue due to typical factors that might impact a business. To calculate this figure for your business, add up each of your standard monthly expenses (rent, utilities, payroll, costs of goods sold, etc.) and multiply by your target number of months.
Of course, the recommended amount of cash in reserve varies depending on the kind of business you run and your stage of growth. As Microsoft Business Insights notes, “A year-round business with stable expenses can often keep more in cash reserves. A seasonal business may find it easier to keep less cash on hand.” Other factors may include projected future expenditures or your expectations for growth. For example, if you’re preparing to make an investment, consider those costs in your calculations. If you’re gearing up for a phase of rapid growth, you’ll want more cash on hand to meet new commitments.
Once you’ve determined an amount that would meet your expenses and give you confidence in your ability to weather a challenge, you have to commit to building up that cash in reserve! Look at your budget to determine how much you can start saving monthly and how many months it will take to create a sufficient reserve for your business. Don’t forget, your budget is a powerful tool for setting and achieving financial goals!
The last nine months have presented us with challenges and opportunities that we didn’t expect. Now, we’ve learned a lot of hard lessons and can be stronger and more prepared as we move into the future. If you still need to be convinced of the importance of cash reserves, consider how a sufficient reserve might have made your life and work easier over the past few months! The time to commit to saving more is now.
At e2E, LLC, our small business leaders have experience and expertise in every area of small business management and growth, from marketing to finance and beyond. If you’d like to enlist their expert guidance to build a cash reserve or discuss how to use yours wisely, contact us today to learn more!