No matter what your business goal, cash reserves are an important part of your strategy. That’s because without having reserves, you can put your company’s future at risk. And that can affect yours and your business goals!
Many SME businesses in the UK have strong reserves. A study by Alicia Bank last year showed that market uncertainty meant small and medium companies were saving cash. They accrued £273 billion in reserves in UK banks, the research found.
If your business isn’t one of those, then let’s look at how it can benefit from strong cash reserves.
What are cash reserves?
Cash reserves are the liquid assets your company requires to meet short-term funding needs, including emergency funds. It is often known as a cash flow reserve.
Why you need a cash reserve
It’s always worth having reserves should you have cash flow issues. For example, if you are relying on one or two large invoices to be paid without cash reserves, it could create problems if any payments are late. Your cash reserves will cover any immediate payments until those invoices are paid.
The cash reserve is essentially a buffer for anything that is unexpected. All businesses should have reserves, but some don’t. Others may not have enough. We’ll look at how you can calculate what you need.
But as well as being a buffer, a cash reserve can also help you:
- With future expansion plans, as you won’t need more expensive credit options.
- Avoid high-interest loans or credit cards for short-term needs.
- Finance liquid investments that will generate better returns than bank interest rates.
How to calculate your cash reserves
It is recommended that you keep enough in your reserves to cover between three and six months of expenses required to operate your business. If you don’t put enough to one side, you could run out of cash. And if you put too much into your reserves you run the risk of missing out on better long-term investment options.
There are four steps that help you calculate the ideal reserves for your business.
Analyse your data
Financial data is extremely important for any business. It shows you how healthy your company is and helps you understand where to make improvements. By analysing the data, you can ensure you have the right amount in your reserves. Looking at six months of financial data will help you calculate your outgoings. You must include rent, insurance, salaries, subscriptions and other fixed costs. These are costs that are the same each month. Also calculate your variable costs, such as VAT, payroll changes and seasonal purchases. These are costs that fluctuate.
How much cover do you need?
The correct amount depends very much on your business model. Stable service-based businesses might only require three months of reserves. But seasonal businesses, such as a gardening supplies company, may need six months or more. That’s because they have longer spells where they may have lower income.
Get set for shocks
Nothing in life runs smoothly and that is particularly the case for businesses. Seasonal companies might be affected by unexpected weather events. And who would have guessed we’d all be told to stay at home for months on end? Many hospitality businesses suffered during lockdown. As the saying goes, you never know what’s around the corner.
From market stock crashes, supply chain delays or even good customers closing their doors, you need to be prepared. You may also be affected when clients or customers delay payments. This can affect your cash flow negatively and you may need to use your reserves to cover expenditure while you wait for payments to be made.
Future costs
You cannot ignore future costs when working out what reserves you require. For example, if your business is growing you may need to take on more employees. Or you may need to invest in new equipment. Either way, not allowing for these costs could mean you don’t have enough in your reserves.
How do I build a cash reserve?
Once you know how much you need to save after analysing your data, the next object is to build a reserve. Don’t be tempted to take out a loan to build it as that ultimately costs you.
Using retained profits is the best way to build cash reserves. Even if it’s just a small amount that you put aside each month – much like a personal savings account – you can soon reach your target. Decide how much you need to set aside, for example 4% or 5% of revenue until your target is reached.
If you automate your payments, it ensures your target is met without you having to think about setting cash aside. Make sure you review your target regularly. You could do this quarterly. It helps you decide whether you will meet your goals with the current reserve or whether you need to adjust it to cover your needs.
Price your goods or services with enough margin to accommodate your plan to make savings for your reserve. Only a small increase can quickly build your reserve.
Don’t forget that if you use your cash reserves you then rebuild them. Overlooking that can create future problems in your business!
Where should I keep them?
Whilst your cash should be accessible we don’t recommend a safe! A business savings account that offers easy access is ideal. The interest might not be high, but the cash is there as a buffer not a way to create income.
You can get higher interest rates from fixed-term accounts. If you think you could manage with a 30-day notice account, then that can give you a little more than basic interest rate accounts.
No matter what you use, ensure the account is protected by the FSCS scheme that covers up to £85,000 per banking licence per business.
What should I do next?
If you are unsure about where to start with your cash reserves, then contact our team today. We can help you understand what you need for your business and how to achieve your goals.
