Asking, "How much cash does my business need?", is a question you’ll find yourself scratching your head over repeatedly.
No magic number will be exactly right for your business as it’ll frequently change with its growth. The classic rule of thumb is maintaining three to six months' operating expenses, which may, or may not fit snug with your business.
You can use the following tactics to estimate how much cash you will likely need for your financial year and utilise these as your cash needs change. How much money your business requires largely depends on what stage your business is at, how much it spends, your financial business goals, and what backup or emergency fund plan you have in place.
The Profit First Cash Management method shows small businesses how to better manage their finances through an expert-led masterclass - It’s financial freedom at its simplest!
Ask me all about it today!
So let's begin with your stage of business.
What Stage Is Your Business In?
You could be a brand new business in the start-up stage, a well-managed established company, or anything else in-between. Whichever stage your business sits at, our guide will improve how you reassess your cash requirements, making the process of analysing your finance needs faster and easier.
If you’re a reasonably new business, exploring and evaluating your cash needs is essential to making your financial audits a simple and effective process.
As a new business, you won’t have historical spending patterns as a reference. However, historical spending patterns are not essential when planning future financial decisions. You can also work off comprehensively outlined forecasted expenditure to estimate potential outgoings. If you do consider yourself adequately established, you will have cash flow patterns, which will help indicate your economic forecast.
Still, your historical spending patterns are not always the whole picture. The following tactics will be an excellent tool for reassessing your financial position and adjusting your cash needs accordingly.
Our Profit First system allows new and existing businesses to finally get a grasp of their finances from a more personalised perspective.
Moving further, let's determine how much cash your company uses by calculating your operating cash inflows and outflows.
How Much Cash Does Your Business Use?
Determining your operating cash inflow and outflow is a good start when discovering how much cash your business uses over specific periods in your financial year.
Your operating cash inflow is any money entering the business from customer payments, investments, or financing.
Your operating cash outflow is any money leaving the business, from payments towards suppliers or bank loans, dividends paid out, employee salaries, and other operating costs.
Your completed operating cash-flow projection will show approximate future expenditure for your coming financial year. This projection provides a baseline or example to work from for the next time you analyse your expenses and create your next financial forecast.
Ensure that your forecast shows a positive cash flow (that your business has more money coming into it than out). The number one reason businesses fail is that they run out of cash due to a negative cash flow or neglected financial imbalance.
The Profit First Instant Assessment guides businesses in the right direction providing an extensive evaluation of where money is actually being spent and where it could be saved.
Now that you’ve calculated your approximate cash usage, you can create a budget. This budget can include how much operating cash you’ll need and how much of a ‘rainy day’ fund you should set aside for any unforeseen hiccups that could appear during your upcoming financial year.
Now you can consider any financial goals you want to implement and if they will affect your budget. Financial goals almost always have risks attached. It’s best to think about these when forecasting your financial year, as they can potentially steer your profit margins either along the right path or onto rocky shoals.
What Are Your Financial Goals?
Financial goals are a significant part of deciding how much cash your business needs. If yours are sizeable, you’ll require substantial savings to support your plans and expanding costs.
Substantiating financial goals can be risky, as reckless and unsustainable spending can lead to incurring fixed ongoing costs, if and when plans don’t proceed accordingly. It is important not to overstep here, and you need to hold only as much cash as possible, rather than holding unnecessary ambitious funds.
Suppose you are a small business with smaller financial goals, such as striving for steady and manageable growth. In that case, you will want to keep your inventory, non-essential spending, and excess cash to a minimum to avoid unnecessary overhead costs. If not kept minimal or within reason, you may fight an uphill battle with costs simply trying to break even.
The Profit First method involves managing money by dividing finances between accounts including expense, profit, or vault accounts for improved cash flow organisation.
Businesses of any size should always have a backup plan involving where to get cash if the business runs into trouble.
What’s Your Backup Plan?
Business is slow, your accounts receivable are growing, and you have bills to pay. Money is thin, and you are starting to feel nervous.
Two questions arise:
Where can I get cash?
When can I get it?
You’ll quickly learn that having quick cash source options could be a saving grace at some point along your business journey.
As you’ll learn through the Profit First method, a dedicated Profit Account can be used partially as a savings backup plan for your business.
In your operating cash-flow projections, you may find that in some areas you may expect to need a cash injection.
Overall, there may be times you need to access fast cash.
Sometimes funding can take up to several months, but usually, these long wait times are for larger bank loans or other significant influxes of money, as they require much time and effort to apply for and then acquire.
You must also prepare and plan for the more minor cash needs, including where you will get the funds and when you predict you can source them.
A few fast-access cash options you could consider:
Asking vendors for credit terms
Incentivising customers to pay earlier to lessen the impact of accounts receivable
Leasing instead of buying in any areas possible
A bank line of credit as a safety net
Creating an emergency fund.
Some of these options may not work for you, but they are examples of tools to use in desperate times.
We want to emphasise creating an emergency fund. You may fall into a problematic space financially due to unforeseen circumstances, and an emergency fund is undoubtedly a good option for companies thinking ahead.
What’s Your Emergency Fund Plan?
As mentioned, an emergency fund (or cash reserve) may not be an attainable goal for all, particularly for smaller businesses. However, we recommend you plan to start one ASAP.
A Profit First ‘Profit Account’ is designed to help you build up savings in conjunction with a vault account. The idea is to reserve between 3-6 months' worth of business expenses, alongside taking a profit distribution each quarter.
You can cater an emergency fund to your business's abilities and decide to put aside as much or as little as suited for your business. Your profits should fund the emergency account and only small portions of your monthly revenue. Adding between 2 - 10% of your monthly income to this fund is a great way to build financial security in the background of your daily operations.
Cash reserves are precisely that, a reserve. Imagine an important client generates a large order of products requiring you to employ three extra employees. It’s the end of the week and employee payday is upon you, but your client is not required to pay until the month’s end.
This scenario puts you in a difficult position financially. A cash reserve exists for times like this when difficult situations arise that require immediate remedy. With your reserve, you may pay your extra employees and replenish your emergency fund to its original state when your clients' payment is processed.
Contact us today.Via our website and book you consultation.
Comments