LearnHow much cash should you have in the bank?

Ryan
writes on March 19, 2007

As a small business owner (there’s just five of us at Carson Systems), I’m always wondering how much cash reserves we should be keeping in the bank.

At what point should you stop saving for a rainy day, and start spending on growing the business? The answer is different for everyone, I’m sure.

However, it just hit me: We could do a little anonymous survey and it would help all of us to get a better feel for what everyone else is doing.

If you’re a business owner, please fill out the form (it’s completely anonymous, don’t worry) and I’ll reveal the results here on Carsonified in a few days.

Fill out the form here. Thanks for participating

21 Responses to “How much cash should you have in the bank?”

  1. 12 months of expenses sounds like way too much. If you are ever in a situation where you need to sit around for 12 months with no cash in then you need to consider a) closing shop b) laying people off/reducing costs c) financing for the assets you are carrying (i.e. contract financing, receivables and inventory financing etc).

    The best rule is to know your buiness and do forecasts with a bunch of different senarios (delayed billing, delayed collections, etc.) and then ensure that you have some financing in place (i.e. line of credit) to cover the worst contingencies.

    Planning for this with your bank ahead of time gives you more credibilty than if you run in at the last second with your hat in hand.

    The next most important thing is to carefully manage growth. Don’t blow your wad chasing sales while ignoring cash flow and the bottom line.

  2. Jeremy W. on March 20, 2007 at 1:17 pm said:

    I agree John. In the beginning few years, maybe you can not achieve this but just after 2-3 years, you can store a good cash in your bank account.

    Of course, this is directly related with your management style. You may decide to share the annual profit at the end of every year and of course this will avoid you to have a good cash in your bank account for rainy days.

    In my opinion a small business or start-up shouldn’t distribute annual profit to partners for a few years at the beginning. In this way, in just 2 or 3 years, you can have a good cash in your bank account for rainy days. But I must admit, this is hard to achieve 🙂

  3. I’ve been working for myself for nearly 10 yrs now and haven’t managed to maintain a consistent buffer for lean times.

    I aim to get 3 months in the ‘just in case’ account but something always seems to stop it happening – equipment goes belly up, late-payers cause cash-flow angst, colour laser needs whole set of new toners etc.

    ‘hand to mouth’ is not a good basis for running a business but it’s what I’ve got used to dealing over the years. The ‘feast or famine’ nature of my workflow has been a significant factor in this.

    I’m now at the stage where I want to bring in a junior to help grow the business, to do some of the ‘doing’ so I can work ‘on’ the business.

    I’m doing the plan for the next few years where I hope to stabilise the workload – I building the plan on the basis of needing a consistent 3 month buffer. 12 months would be nice but in my experience, I just can’t see it as a realistic option.

  4. I’m surprised by how many people are saying 12 months money – that could in a small company equate to quite a large proportion of the company’s wealth.

    Thinking this through that would be:

    Small business with 3 employees (on a salary of £30,000? each) plus rent (£12,000?) plus business expenses (£25,000? pa) that’s £127,000 in the bank as a contingency – it would be nice if you could – but seems like an awful lot to me.

    Are these the kind of figures people are looking at when they say they have a years money?

    Looking at different company’s balance sheets I’d say many companies (of this kind of size) do not have anything like this “cash in hand” at the bank. In fact, from what I’ve seen the bigger companies seem to have less cash in the bank per employee head than smaller businesses.

    I think this is a really interesting discussion and I agree that other useful ways of looking at it would be to say “we have 3 x our monthly business costs (including all salaries) on hand at the bank at any given time.”

    Anyone else care to share an opinion?

  5. 3-6 months balances growth with risk assuming self funded. If you’re burning money I’d want to have 12-15 months in the bank when I started working on my next round.

  6. I work for a fairly large consulting company (1000+) and I know that the company has enough money to survive for ~90 days.

    If sales slow down and grind to a halt everything gets “restructured”. Look at Andersen and you’ll see, 90 days after the scandal they were gone.

  7. It really can be different for every company. I would say – best practices would be to keep at least 6 months worth of expenses on hand. Obviously, this would vary from company to company.

    When you dip below 6 months – it’s time to raise money – or re-think your business model.

    Dave

  8. Jeremy W. on March 19, 2007 at 3:48 pm said:

    Just one more point: If you have a recursive income (memberships just like in DropSend), then you can reduce the buffer period to 3-5 months.

    But if you are selling a service or software and need to achieve the at least same revenue every month, it will be wise to keep buffer period high.

    Comments?

  9. Jeremy W. on March 19, 2007 at 3:46 pm said:

    In my opinion, you should also consider targets in the defined ‘buffer’ period. For example, we try to buffer 12 months cash in the bank. We consider our annual plans (new staff hiring, new hardware purchases, etc.) so even there is no coming money for one year (I wish I don’t have such a problem — God please!), we can survive, just proceed as we are earning money and hire new staff.

  10. I tend to agree with Jeremy and Johnny. Using the absolute amount of money as a reference can be very misleading.

    Your monthly Operating Expense (OpEx) is definitely a better indicator of how much money you need to keep liquid and accessible. I prefer to keep the buffer at 9 to 12 months.

    Once you’ve figured out your monthly OpEx, and you’ve determined the number of months you want as buffer, you then adjust the amount further by considering the following factors:

    a. any expected, sizable, one-time expenses (usually ramp-up costs for a new project)

    b. any expected difficulties in collecting receivables. A good indicator to track is your Days Sales Outstanding (see http://tinyurl.com/k7xqn)

    c. any expected revenue shortfalls (i.e., when the pipeline looks uncertain)

  11. It does not make sense to say an amount. You can have two persons, but spend a lot of money on hardware, and servers, as well as you can hire a lot of people but do not have any expenses but salaries.

    I would say that I try to keep 3-6x monthly expenses in my bank amount. In most cases, if you’re encountering cash flow problems that take more than this time, it could mean that you should close your business, or at least rethink it.

    Also, it’s worth noting that money in the bank sometimes gives a false impression that you’re secure. It’s not true. You’re never secure. You need to innovate all the time, as you don’t know, say, whether Google is not working on your product right now.

  12. Thanks everyone – good thoughts. I’m looking forward to the results.

  13. Good stuff, as we are coming to expect! However I wonder if you need to refine this a bit, too distinguish between small businesses which are funded by the owners, those funded by outsiders. You might have a different view on use of business reserves for expansion of your mortgage is at risk. Also, distinguish between those where the owners are living on the salary from the business and those not.

  14. this depends on whether you wish to manage your own growth or seek outside investment. if you are seeking outside investment, you generally want to have some money in the bank so you look like you don’t need the money! this isn’t so important for a first round – but in subsequent rounds, it’s best to have 6-9 months worth of operating cash in the bank when you start looking for a next round because a) the process takes awhile b) you never want to be in a position where you *need* to close a financing of some sort to continue operating.

    also, as with any expenditure, you are managing investment risk. spending the coffers on a one time purchase like hardware is different than spending on an employee who will be a continuing expense, but perhaps have a larger payoff in the long run.

  15. I can’t help but feel that you might be asking the wrong question…

    Instead of asking the exact dollar/pound/euro amount and trying to match that to number of employees, the answers you could’ve received could be more dynamic.

    I would say you need at least 3 months of cash in the bank… basically because that lets you operate for 3 months without any money coming in (something we all hope never happens).

    3 months of cash here in NZ would be substantially lower than most other Western nations when converted to another currency (especially pounds sterling…). My point is, I think my answer to you is a lot more relevant if I tell you “3 months” rather than saying $x for y number of employees…

  16. Jeremy W. on March 19, 2007 at 10:34 am said:

    Ryan, we are in the same market with you and we try to keep {monthly fixed expenses x 12 months} as cash in the bank for rainy days. But I must admit that sometimes, we invest some more money to hardwares, softwares or marketing and this cash goes down until {monthly fixed expenses x 4 months}

    I am going to fill in the form now 🙂

  17. It is not that easy to say ‘I have £x in the bank’ as it will fluctuate.

    Perhaps my situation is different as I am not running a web app, but am running a studio (though the principles are the same). For us we are dependent on getting paid for invoices we submit. Hence cashflow is key to staying in business.

    We also often get paid at completion of a project, but that project might have been ongoing for months. So money in the bank means we can pay the wages, studio rent etc. Sometimes this dwindles down we are in our over draft (which I HATE), but then we know that we have money coming in to take us back up where we were before.

    So I try and keep some money aside for when we will have a lean spell of no invoices going out. But it is also important not to get fixated too much with that. Keep some aside for investment in the business — taking on that extra member of staff for example to take the business forward, or buying that new computer because the old one is so slow it is costing you time.

  18. Ryan,

    I too have wondered about this.

    It’s very perplexing when running a business and something it is difficult for people in business to share or discuss openly.

    We have good cash flow and reserves but somehow it’s impossible to judge how much cash we need “just in case” or indeed how much we can speculate with when looking at other areas of our business.

    Every business type will clearly have different needs.

    I can’t wait to see the results.

  19. I just filled it out – I assumed it was in $US ??

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