The COVID-19 pandemic has highlighted the importance of saving money for a rainy day. While thousands of small businesses closed permanently in the spring of 2020, the ones that had cash reserves on hand for emergencies fared much better—especially considering the hurdles and delays that came with government aid like the Paycheck Protection Program.
It shouldn’t have taken a global pandemic for small businesses to see the value of having a cash reserve, but nonetheless, many owners are now more aware of the importance of financial stability. Having cash reserves available can help you cover rent, utilities, and other common expenses until you’re operational again.
Taking steps to put away money isn’t easy, but it is important. Follow the steps below to build a cash reserve for your business.
Step one for building a cash reserve for your business is understanding how much money you truly need. Look at your finances and determine your average monthly cash outlay. Based on your business’s needs, set a goal to save enough cash to withstand whatever timeline you believe is necessary.
At the bare minimum, you should have at least 3 months’ worth of savings in your reserve at any given time. Ideally, you would save up to 6 months’ worth.
Review a list of non-negotiable expenses each month. These costs include your rent, employee pay, and vendor agreements. If you want to save even more, you can look for negotiable expenses (or expenses that you could cut if your business closed) and save for those as well. These costs can include marketing, materials, and inventory.
To calculate your ideal business cash reserve amount, understand that you should expect zero revenue during an emergency closure. Your business will need to rely on your reserves entirely. For example, a hurricane could shut down your business for a month and require repairs. During this window, there may be no way for your business to earn a profit, and you would need to eat into whatever cash reserves you had.
You never want to face a situation where your business will have to close for 3–6 months, but having enough cash available to sustain your company through that downtime will give you some peace of mind.
You likely have several fixed expenses each month—these costs are recurring and do not fluctuate monthly. Common fixed expenses for small businesses include rent, insurance, and car payments for fleet vehicles. If you are serious about setting up a cash reserve, treat it as an additional fixed expense.
Move your savings into a separate account, or create a label within your accounting system for the cash reserve. This way, you will allocate funds to the cash reserve automatically before you look at your more dynamic costs or calculate your monthly profits.
You don’t need to set aside much each month (even a few hundred dollars monthly will add up over a year). However, the sooner you have your reserve built, the better off your business will be if you need to close suddenly for an extended period.
Whether you are a small business owner with a few employees or a growing brand with a large team, develop a policy for when it’s acceptable to pull from your cash reserve. These guidelines can be a simple written agreement that you keep in your accounting documents or part of your company’s financial bylaws.
This guide is meant to prevent abuse from you and your team—you don’t want to pull from your cash reserve for small problems and repairs, diminishing the amount you have saved. It’s entirely possible to eat away at your reserve if you don’t have a plan in place for when to use it.
Consider creating guidelines to approve the use of these funds. For example, you could require both co-owners to sign off on using funds or require board or investor approval. These steps help create safety nets within your company to protect your funds until you really need them.
If you dipped into your cash reserve during the pandemic or needed it for other emergency expenses, don’t forget to pay it back afterward. Cash reserves are meant to be used from time to time, but they are also meant to be repaid when used.
As COVID-19 has shown us, you cannot predict when chaos will strike—if you’re not prepared financially for any event, then you risk losing your business. Because nobody can predict the future, it’s important to make sure you’re always ready for the worst.
If you’ve followed the advice above, you’ll have established your cash reserve as a fixed expense so it will begin replenishing quickly. However, if you drained a large portion of it, you might want to increase your monthly repayment amount or even consider adding a lump sum to the reserve.
Don’t get overwhelmed with the idea of needing several months of savings immediately. If you feel like creating a cash reserve is an impossible task, then you’re more likely to give up in a few months.
Know that your reserve is going to start small, and that it’s okay. Any money you have set aside will help. It doesn’t matter how much or how little you put into your cash reserves—over time, that money will grow. Eventually, you’ll have a safety net to keep your business thriving through any crisis.