Cash Reserves: How Much is Enough?

Determining the right amount of cash to keep in your business account is crucial. Many business owners take one of these approaches:

• Keeping an arbitrary amount that “feels” right
• Ignoring it until payroll or expenses are due
• Stockpiling excess cash
• Carefully calculating their cash needs

 

Why Cash Reserves Matter

Maintaining an adequate cash balance helps with:

• Daily Operations: Ensuring you can cover payroll, rent, utilities, and loan payments.
• Working Capital Cushion: Managing cash flow gaps caused by accounts receivable and inventory.
• Growth Capital: Funding expansion, hiring, or equipment purchases.
• Emergency Reserves: Protecting against unforeseen financial challenges.

 

Strategies for Determining Cash Reserves

Here are two simple approaches:

 

1. Months’ Operating Expenses

A basic rule of thumb:

Minimum Cash on Hand = Monthly Operating Expenses × 2

 

 

 

 

Limitations: This method doesn’t account for profitability, working capital needs, or expense-to-revenue ratios.

 

2. Working Capital Approach (More precise method)

This formula considers expenses, profitability, and cash flow cycles:

Cash on Hand = (Daily Expenses × Cash Conversion Cycle*) + Safety Buffer

*Note: The length of time a business’s funds remain tied up before being converted into cash.

 

 

 

 

 

A company with seasonal fluctuations should maintain a larger safety buffer, while a business with steady revenue (subscriptions, memberships, etc.) may require less cash on hand.

 

Key Takeaway

You don’t need to calculate cash reserves constantly, but reviewing them a few times a year is essential. Ensuring adequate reserves helps sustain operations, cover cash flow gaps, support growth, and safeguard against financial downturns.

If you’d like to learn more about the financial operation of your small business, contact your Wyoming SBDC Network advisor who is available to provide no-cost, confidential assistance. Get started today by clicking here.

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About the Wyoming SBDC Network: The Wyoming SBDC Network offers a large amount of business expertise to help Wyoming residents think about, launch, grow, reinvent or exit their business. The Wyoming SBDC Network is hosted by the University of Wyoming with state funds from the Wyoming Business Council. Funded in part through a Cooperative Agreement with the U.S. Small Business Administration.