How Much Cash Should a Business Keep on Hand?
For most newer small businesses, figuring out what to do with excess cash isn’t a big problem – stretching it to make sure that bills and expenses are covered. But, as the company grows and establishes itself, lots of entrepreneurs find that they are gradually building up large cash balances in the bank.
After smiling at the realization, they are faced with an interesting question: how much cash should a business keep on hand?
Finding the answer requires a bit more complex thinking than you might expect. To see why, let’s look at the upside and downside to having a big balance in your business checking account.
The Upside: Liquidity is Good for Your Business
Obviously, having a lot of free cash in the bank is better than having too little. Lots of companies struggle with cash flow (and often unexpectedly), so retaining a bit extra in savings is an easy way to ensure your business can ride out a rough patch and meet unexpected challenges.
Additionally, when you have lots of cash in the bank, it improves your financial statements and makes it easy for you to secure lower-cost financing. So, if you want to further ensure that you won’t have any cash flow issues in the future, keeping some on hand now is a good idea.
One more underrated benefit of having lots of cash in the bank is that it’s available for you to use if you spot any profitable opportunities. If that once-in-a-decade chance to buy out a competitor, expand into a new location, or take advantage of a new opening in the market comes up, you’ll have the funds on hand and ready to use.
The Downside: Too Much Cash Can be a Problem
If cash is so great, then how could your business ever have too much of it? Believe it or not, there are a few ways in which a huge bank balance can be a problem – albeit a minor one.
The most obvious challenge to having a cash-heavy position is that it makes you a target for all kinds of people – including thieves, dishonest bookkeepers, and even sometimes government regulators. Keep too much cash sitting around, and someone is likely to see if they can make a bit of it their own, legally or not.
Next, there are problems with keeping tabs on lots of cash. Even if you don’t worry about fraud, you do have to keep an eye on your balance sheet to see what’s coming in and out. It’s easier to lose track of small transactions in a sea of available cash.
And finally, we come to the real issue – when you keep lots of money in cash, it isn’t doing anything for you. Cash that’s just sitting in the bank isn’t earning the interest it could be. It also isn’t helping your business grow, or reducing interest paid on debt. In essence, it’s just sitting there when it could be earning a higher return or making your business stronger for the future. Chances are, there will be something you’ll wish you would have invested in five years from now. The paltry interest rate you earn on a business checking account isn’t that investment.
So, How Much Cash Should Your Business Hold Onto?
As you might expect, there isn’t a set formula about how much cash to hold onto in your business. However, a good rule of thumb is to start with a solid year’s worth of expenses, plus a small buffer that you could use in an emergency, or to take advantage of an opportunity.
Beyond that, it might be a good idea to look for other places to invest spare cash you made in your business. Money Market Accounts, CDs, and even business acquisition are all reasonable options, as are debt repayments and volume purchases that reduce your overall expenses.
Ultimately, it’s up to you to decide how much cash your business should keep in the bank. As you do, remember that having strong cash flow and some healthy reserves is a good idea – but that too much cash can be a problem in its own right. It’s a good problem to have, of course, but one that still requires thought and attention.