Cash, Should Companies Increase Reserves?
Should we increase cash? That is the question begged by a press release from the Association for Financial Professionals (AFP) on October 30th, 2017. The AFP released that their Cash Indicators Index indicates that corporate treasury departments have recorded the greatest change to their cash and cash equivalents positions since they began recording in 2011. The AFP further indicates that this is a sign that corporate treasury departments are concerned about the global economy and stockpiling reserves in response. (“US Firms are Worried About the Economy“, 2017)
We don’t consider ourselves financial prognosticators, that is not our business. We like to keep things simple. If your business is performing well right now, it is a good time to evaluate how much cash you should have available. Examining cash needs is good when you anticipate future expansion. Knowing your cash needs also helps when there is a bump in the road. Finally, your relationship with the bank is like dating, they want you more the less you need them. If part of your corporate financing strategy involves a bank, start the conversation when things are good.
How Much Cash Should I Have?
The recommendation from SCORE is to have available 3-6 months of cash available. Score uses two methods to determine monthly cash required, net cash burned and gross cash expenses. Net cash burned is simple to calculate. Net cash collected that month, including sales and receivables, minus cash expenditures. The difference between cash collected and expended is your burn. Score notes that the gross cash expenditures method is the most conservative estimate of cash needs. (Shelton, 2015) The added emphasis that expenses and revenues are based on cash collected and disbursed is our edit.
A lot of companies don’t hold the SCORE recommended amount of cash. It’s often consumed by operations and growth rather than stashed away for a downturn. So if the SCORE recommendation is 3-6 months, what is right for you? This depends on your tolerance for risk as a business owner. The minimum we would normally recommend for a client is to have on hand or access to enough cash to sustain them through defensive cost-cutting, meet any contractual obligations, and maintain adequate working capital. This could be an owner who is willing to make a capital contribution quickly, reserves on hand, a revolving line of credit, or other arrangements depending on the company.
Line these arrangements up now and do your homework when times are good so you can rest easier when things become rockier. The math is easy, figuring out how you relate to cash as an owner and developing a strategy to get you there is the tough part.