Cash-Flow Management: How Much Cash Should You Keep In Your Business?

Cash fuels business operations and growth. It pays your employees' salaries, funds marketing and sales programs to acquire and retain customers, buys equipment and facilities and other day-to-day activities. Good cash-flow management ensures you have the right amount of cash on hand to fuel the business.

Typical cash-flow management advice is to maintain cash equal to 3-6 months of operating expenses. But using this for every business in every situation is misleading. 

To determine how much cash to keep in your business, consider the following questions:

1. How much cash have you been using? 

Your monthly cash-flow report provides a historical and seasonal perspective. 

Note the cash received from sales and the cash spent. Subtract expenses from sales to get “net burn."

For example, if you have $50,000 cash received from sales and $30,000 in expenditures, then your monthly net burn is $20,000. This amount usually varies month to month, so it's probably better to use a 3- or 6-month average.

Your “gross burn" only considers cash expenditures; in our example, that's $30,000. This is a more conservative metric since it does not assume any sales occur. Again, use a 3- or 6-month average. 

2. What stage is your business in? 

Historical spending patterns are a good starting point in considering cash-flow management and future spending plans. However, the past is not necessarily the best predictor of future needs. You should also consider the stage of your business in your forecast.

In a growing business, accounts receivable and inventory increase to support expanding sales. If your business has a product, then you need to make the product before you can have a sale. 

If the sale is made and you provide payment terms (i.e. customer does not pay cash or use a credit card), then you have an accounts receivable. In both cases, you are funding the business until the customer pays.

Accounts receivable and inventory growth are often overlooked; you need cash to fuel this growth.

3. How much cash do you plan to use? 

Your budget or financial plan will show cash-flow projections covering the next 12 to 15 months. If you do not have a budget or one with this detail you will need to develop a forecast.

I recommend being conservative in your forecasts as a part of your cash-flow management. Actual results often differ from projections. Keep in mind that expenses are usually more predictable than revenues because many are relatively fixed, such as payroll and rent (often a business's largest expenses).

4. How long will it take to get more cash? 

From the above analysis, you now know your cash needs for the next 12-15 months. Next, consider how long it will take you to get more cash if needed.

If you are funding the business from your own resources, maybe it takes 3-5 days to write a check or sell a security.

However, if you need a bank loan, it might take two months—one month each to find a bank willing to make the loan and do the paperwork. (Assuming you have a business plan in almost ready condition and have maintained good bank relations.)

Raising funds from angel investors can extend the timeline considerably. If you go this route, count on it taking 6-9 months to prepare the business plan and investor pitch deck, make presentations to several angel groups to find one that is interested and a good fit and wait while they conduct their due diligence and make a decision.

There are other funding sources that might have shorter time frames like:

• asking vendors for credit terms, 
• increasing credit card balances, 
• incenting customers to pay earlier, 
• borrowing from family and friends and 
• leasing rather than buying equipment. 

It is also good practice to have a bank line of credit to utilize quickly when needed as a safety net .

5. How much cash do you need to keep in the business? 

Once you know how much cash you plan to use and how long it will take to get more cash if needed, you can determine how much cash you need to keep in the business. 

For example, if you plan to spend $50,000 a month and obtain a new bank loan to fund cash needs, then you should probably keep at least $100,000. However, if you plan to use angel funding, you might want to keep at least $300,000 in your bank account. (I say “at least," since this is the minimum amount. Depending on your risk tolerance, you might want to have more, or have a safety net like a bank credit line.)

In all cases, if you know that sales receipts will occur, you can reduce the cash amount held using net burn rather than gross burn. 

6. When is the best time to seek more cash? 

The best time to obtain funds is when you do not need them. 

Sounds counterintuitive, but at these times you aren't desperate to take the only offer made. You can shop for the best terms and negotiate. This is the time to get a bank credit line.

7. Do I have too much or too little cash? 

Two items frequently mentioned for business failures are undercapitalization (not enough cash) and overcapitalization (too much cash). The first reason is easy to understand and is what this article has primarily focused on.

But companies can also get into trouble when they have too much cash, as they often incur ongoing fixed costs by undertaking projects, hiring staff, buying equipment, moving to larger offices, etc. Often these decisions are made with less rigor than when cash was tighter.

If your company has “excess" cash beyond the forecasted needs, then distribute it to the owners or shareholders, or put the cash into a separate account, rather than make suboptimal decisions just to use up the excess cash. That makes for smart cash-flow management.

Read more articles on managing money.

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