Cash reserves/cash on hand are the amounts of cash accessible to a business once outstanding balances have been paid. It’s an important metric to measure and determining the correct amount can help business owners get a full perspective of their business’s health while reducing the stress that accompanies uncertainty.
However, it can also be a major pain point if cash flow isn’t optimized. For example, if your ending cash on hand balance for May was $30,000 and your monthly payroll is $50,000, you’re likely struggling to make payroll each month and pay your vendor bills. This is because there is simply not enough cash on hand on a monthly basis.
To identify your cash on hand, simply look at your balance sheet (not your online banking account) ending on the last day of the previous month to determine the ending cash balance going into the current month. Once you have this figure, the next step is uncovering where your cash on hand needs to be in order to produce the best cash flow results.
Unfortunately, there is no magic number that determines the right amount of cash on hand. This important figure varies from business to business. Essentially, the sweet spot for a particular business can be determined through cash flow forecasting. The most effective ways to conduct cash flow forecasting are either by working with a cash flow specialist who focuses on these metrics, or by using cash flow forecasting software. The best versions of this software can provide an 8-month projection of the beginning/ending cash on hand balances based on a 4-month trend of the user’s business financials. It should also allow the user to easily plug in different metrics, such as projected monthly revenues and projected monthly outlays of cash to create the forecasts that will be most helpful to them.
If you’re wondering what your cash on hand balance should be, consider these scenarios:
- Should your beginning/ending cash balance be 2x your monthly payroll amount?
- Should it be equal to the average monthly outlay of cash, meaning are all of the expenses paid on your profit and loss + debt servicing + owner’s distribution?
- Should it be 3x your monthly expenses?
Bottom line, this figure is different for every business. It’s best to educate yourself on what will work best to help optimize cash flow, and if you are not doing any cash flow forecasting, you are basically “winging it.” Stop being reactive and acting upon the feeling of pain each month when you are struggling to make payroll or paying your vendor bills. Learn to be proactive, create a strategy to help you know what this key figure should be and feel empowered when reviewing your monthly financials. If you’re feeling lost, sign up for my next webinar.
To understand what this looks like in “real life,” let me share an experience I had working alongside a CPA and a dental consultant for a dental practice. The CPA was focused on minimizing the bottom line to help reduce tax liabilities. The dental consultant was focused on production to collections and driving the dental team toward that production number. They were following the numbers in their dental software and not watching the balance sheet. My role was to follow the money into the bank accounts, and record those balances on the balance sheet. This added another level to the financial conversation because until I brought all the pieces of the financial puzzle together, the consultant was not including debt servicing in their conversation to drive the production numbers. At the end of the day, the dentist could see that we needed to add another $10K to the production goals to help manage the cash on hand balances so that the practice didn’t run out of money or struggle with low cash balances each month.
From my seat at the table, the correct amount of beginning/ending cash balances will be defined by how easily a business owner can find peace of mind at the end of the day and go to sleep without worrying about cash flow each month.
Find confidence and comfort in the financial health of your business. Schedule your complimentary consultation today by calling (303) 835-7992.