Kerry Packer said that ‘cash is king’.
The media tycoon was referring to the opportunities a decent cash reserve can bring. More importantly, it can prevent disasters.
Cash is the oil that greases the engine of a business. Managing cash flow is probably the most important process in a business or organisation of any kind. Yet it’s one that many fail to do effectively.
When Bill Gates started Microsoft, he was so concerned about having enough money for payroll that he vowed to always have a year’s payroll in the bank. When Microsoft increased staff numbers, the amount of cash kept in reserve had to increase as well.
Bartering facilities are available to exchange goods and services, but think about trying to trade inventory items or services to one of your staff for wages. You most certainly couldn’t do it with your bank to fund a loan repayment. It is never possible to barter effectively when you need it most. That’s why a solid cash reserve is so important.
Business owners who do not manage their cash flow can end up not paying themselves a salary, or worse: spending business money on personal items that have nothing to do with the business – ie. spending what they are not making.
Many profitable businesses have gone into receivership or had a forced sale because they did not have enough cash to fund their growth.
How much cash should a business hold?
It is context driven, and depends on factors such as:
- Does the business carry inventory, debtors and work-in-progress?
- What credit terms do they give?
- What credit terms to they get from suppliers?
A business should be capitalised correctly for these factors at the beginning and adjusted when a significant change occurs in trading conditions (growth or retraction).
To find out what kind of cash reserve your business needs, you need to:
- Get advice from your accountant or a virtual chief financial officer.
- Determine the cash required for trading, eg. inventory, debtors, work-in-progress.
- Decide the amount of cash you need for overheads and to help you sleep at night, eg. at least three months of overheads (wages, rent, etc.).
- Put your reserve in an accessible interest-bearing account.
- Have a system for managing cash and monitor it daily or weekly.
I have spent years working with business owners to ensure their business and personal finances are sufficient so they never run out of money. My experience has taught me that although each individual business (and its owner) is unique, there are similarities. If you have a story about cash flow that you would like to share, I would love to hear from you. You can email me at email@example.com or call me on 0437 000 377.