We’ve all heard the phrase that cash is king (and queen!), when it comes to running a business. Undoubtedly, the most common reason that businesses fail is that they run out of cash at some point.
So how much cash should you have access to at any point in time?
The answers that follow have an element of ideal world about them and it’s certainly not lost on us how difficult it can be to build any element of cash cushion in a business, particularly in a start-up. In many cases the cushion might need to come from access to finance or investors. In this blog, we’re going to focus on what you should be working towards to save yourself from sleepless nights.
We recommend dividing your thinking and your money into three accounts (or four if your business is doing really well!).
1. Operating account
This is your day-to-day current account and is the account from which you will meet your everyday expenditure – everything from payroll to paper-clips. In an ideal world, you will keep the balance on this account in the region of two months’ worth of payroll. You will know then that if your business suffers a short-term shock you won’t be faced with the immediate pressure of not being able to cover the salaries when pay-day comes around. If the impact, looks to be longer term, you will have the time to work out a solution either with your bank or by managed cost-cutting.
2. Tax reserve
VAT and Corporation Tax have a nasty habit of falling due when they’re least affordable. HMRC is an intolerant creditor when payments are late so it’s important to try and budget for the payments as much as you can. Net VAT (namely the VAT payable on your revenues, less that reclaimable on your expenses) is around 15% of turnover for many businesses, but you can quickly calculate your own average by dividing your last four quarter’s bills by your gross revenue. Sweeping this amount of your revenue into a reserve account each month is a good best practice. Corporation Tax is currently 19% of net profit for small businesses. If you can make provision for this each month or quarter too, so much the better.
3. Cash reserve account
This should be an easy access savings or deposit account from which you can withdraw money without notice or penalty. You won’t earn any interest worth speaking of in the current climate, but it keeps the money to one side in case it’s needed. If possible, you should build this account up so that between your operating account, tax reserve and cash reserve account you have about 10% – 15% of your turnover. If you can build cash reserves to this level, you are likely to be able to withstand a severe shock like the loss of a major customer.
4. Investment account
Any surplus over 15% of turnover can be placed into a better yielding savings account or even invested. Just remember that the more illiquid the investment is, the harder it will be to get to the cash if you need it quickly, so you might want to push the amount of the cash reserve up to 20% or more if you are considering investing in something like a commercial property.
These amounts are only a guide and there is no one-size fits all formula. Where your business is in its life-cycle, whether it’s in a high-growth or low-growth industry; whether the revenues are made up of high recurring revenues (e.g. a subscription model) or individual sales will all influence how cash generative your business is and how much it should have access to at any point. The important thing is that you understand the flow of cash in your business and build up the necessary cash cushion to ensure your survival through choppy waters and calm.
CaFE has been specifically designed to help business owners monitor the day-to-day cash flow health of their businesses, provide alerts of short-term shortages and surpluses and allow them to move cash around as needed to optimise their positions. The latest features also allow for longer-term budgeting and planning. Users can easily monitor performance between the plan and actual data and see the impact on forecast cash flow, including the ability to drill down into a worst-case scenario. CaFE does all this without further input from the user once the plan has been created.