As a business owner, you understand the importance of financial stability. However, when building cash reserves, many struggle with determining the right amount. Should it be 10% of your revenue? 30%? Or somewhere in between? There’s no one-size-fits-all answer, but using a straightforward technique, you can determine the ideal cash reserve percentage that will keep your business resilient and thriving.
Uncertainty in Cash Reserve Planning
Imagine this scenario: Your business is doing well, but you’re constantly worrying about unexpected expenses. Perhaps a key client leaves, or there’s an economic downturn. How do you ensure your business can weather the storm without tapping into emergency loans or slashing budgets? This is the uncertainty that plagues many business owners when it comes to cash reserves.
A Simple 10-Question Technique
To eliminate the guesswork, I’ve developed a technique using ten key questions that guide you in determining whether your cash reserves should be closer to 10% or 30% of your revenue. You can confidently set aside the right amount of cash by evaluating factors such as your sales pipeline, accounts receivable, and business growth.
Questions to Determine Your Cash Reserve Needs
Let’s walk through the ten questions that will help you assess your cash reserve requirements:
- Recurring Revenue: Do you have a high amount of recurring revenue, or is it low? High recurring revenue often allows for lower reserves, while low recurring revenue suggests you might need more.
- Accounts Receivable Days: Are most of your accounts receivable collected within 30 days, or do they stretch beyond that? Faster collections typically reduce the need for large reserves.
- Amount of Accounts Receivable: Is your business dealing with a high amount of accounts receivable? More receivables can mean more reserves are needed to cover potential gaps.
- Sales Pipeline Strength: How strong is your sales pipeline? A robust pipeline might allow for a smaller reserve, while a weak one calls for a larger buffer.
- Partner Age: Are your partners younger, or are they nearing retirement? Younger partners can often afford to keep reserves lower, while retiring partners might prefer a more conservative approach.
- Growth Rate: Is your business experiencing high growth or slow growth? High growth can necessitate more reserves to fuel expansion, while low growth might mean you can set aside less.
- Upcoming Purchases: Do you have significant purchases planned in the near term? Big purchases on the horizon often require higher reserves.
- Ownership Structure: Is your business owned by one person or multiple owners? Multiple owners might complicate decisions, leading to the need for more reserves.
- Client Concentration: Does any single client account for more than 10% of your revenue? High concentration in one client might warrant a larger safety net.
- Owner Liquidity: Do the business owners have high personal liquidity, or is it low? Owners with high liquidity might require fewer reserves, while those with lower liquidity should consider higher reserves.
A Customized Cash Reserve Strategy
By answering these questions, you’ll gain clarity on where your business stands and how much cash you should set aside. For instance, if your business has low recurring revenue, high accounts receivable, and a weak sales pipeline, you might lean towards a 30% reserve. On the other hand, if you have a strong sales pipeline, high personal liquidity, and no significant upcoming purchases, a 10% reserve might suffice.
Secure Your Business’s Future
Don’t let uncertainty about cash reserves keep you up at night. Take the time to evaluate your business using these ten questions, and set a cash reserve that ensures your business can survive and thrive in any situation. If you need personalized advice, consider scheduling a financial assessment where we can dive deeper into your specific circumstances and craft a tailored plan for your business’s success.
Remember: Building the right cash reserve isn’t just about survival—it’s about setting your business up for sustainable growth and peace of mind.