If you never run out of cash, you're never out of business. With that in mind, a key part of planning your cash flow is setting up a cash reserve.

“Similar to individuals, all business owners—especially small to medium- size business owners—should have some type of cash reserve," says Andrew Rafal, president and founder of Bayntree Wealth Advisors in Scottsdale, Arizona.

A cash reserve can help smooth over fluctuations resulting from seasonality, losing a major customer or other causes, says Michael Chadwick, a certified financial planner in Unionville, Connecticut.

“What if an owner gets hurt? What if business changes? What if there's a recession? These are all serious concerns," Chadwick says.

Even if major reversals never occur, having a cash reserve can be of benefit, says Susan Scherreik, director of the Center for Entrepreneurial Studies at Seton Hall University in South Orange, New Jersey.

“The ability to save and create emergency funds can actually help the entrepreneur better focus on his or her business because he or she doesn't have to worry as much about emergency expenditures derailing the business," Scherreik says.

Managing Cash Flow to Build a Cash Reserve

The first question about a cash reserve probably is: How much? The answer is generally stated as a number of months' worth of expenses.

“Our mindset is at least three months," Rafal says.

Keeping a close eye on the bottom line, and planning for the inevitable downturns, may not be the glamorous part of the job, but following the money—or not doing so—can make or break a business.

—Susan Scherreik, director of the Center for Entrepreneurial Studies, Seton Hall University

Three months is also the minimum often given for how many months of personal living expenses individuals want to keep on hand. It's different for business owners, according to Scherreik.

“Entrepreneurs should at least double that amount, creating an emergency fund that covers six to 12 months of both living and business expenses," she says.

The next question may be where to stash it. Chadwick recommends setting up a special account separate from other funds, especially for business owners who may lack the discipline to keep from dipping into the cash reserve to fund a tempting new opportunity.

Scherreik says some business owners set up several cash reserve accounts, each devoted to a particular situation, such as unexpected illness or even vacation. As far as the specific type of account, safety and easy access outweigh interest earnings or potential for appreciation.

“Bank savings accounts, money market accounts, CDs and low-risk, short-term, high-quality municipal bond funds are good choices for savings that may have to be tapped immediately," Scherreik says.

A separate matter is how to fund the cash reserve. Rafal recommends business owners send a set amount of revenues to the reserve account.

“If possible, have 5 or 10 percent of all income diverted to that," he says.

It's important for small-business owners to commit to filling the cash reserve from cash flow, Chadwick says.

“We try to get people to treat it as a bill," he says. “We have to treat it as a priority like payroll. Otherwise, it's not going to happen."

One way is to automate it. A business owner can instruct the bank to withdraw periodic automatic drafts from a business checking account and place the money in the cash reserve account so the balance will grow unattended.

Chadwick also suggests business owners juice up funds flowing to the cash reserve any time they finish paying off a loan or reach the end of a lease.

“When a payment goes away, that's a great time to add to their emergency stash," he says. “Take that same number of dollars and start packing that into your emergency fund."

Cash Reserve Alternatives

The arrival of a cash crunch isn't necessarily a sign to tap your cash reserve.

“For ordinary business hiccups, try to stretch your existing operating funds by, say, speaking to suppliers about temporarily easing their payment terms as your first line of defense," Scherreik says.

A bank line of credit can present another alternative. Drawing on a pre-arranged line of credit can work like a cash reserve for smoothing cash-flow issues or funding an opportunity, Rafal says.

“Both approaches are smart," he says. “It's always good to have, beyond your own money, the ability to use somebody else's money as well."

Though stocking a savings account may seem unnecessary to many business owners, having a sufficient cash reserve is more than just a nicety.

“Keeping a close eye on the bottom line, and planning for the inevitable downturns, may not be the glamorous part of the job, but following the money—or not doing so—can make or break a business," Scherreik says.

With that in mind, because building up an adequate cash reserve may take some time, today is not too soon to get started.

“Be proactive," Rafal urges. “Don't wait until the end of the year. Look at this as an important, integral part of the success of the business."

Read more articles on saving money.

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