Once our businesses are up and running we may find ourselves taking access to cash for granted. As the cash flow of the business more comfortably satisfies the daily demands of operating expenses, debt payments, etc. we focus more on sales and business growth than on cash. Sure, we monitor cash levels to maintain a buffer in our checking accounts to be sure that we don’t inadvertently run out, but it’s more of a reactive approach to a critical ingredient for our success.
Cash should be managed like any other input or resource utilized in our business. If we operate with the need for inventory of raw materials or finished goods we manage the level of these inventories to ensure the ability to deliver as promised to our customers. Cash is the inventory (liquidity) necessary for your survival and growth. If you don’t proactively manage it, you may find yourself deficient at a critical point in your business.
How Do We Get Access to More Cash?
In order to proactively manage cash, we first need to understand where to get it. There are three sources of cash. The first is our Retained Earnings. The undistributed profits that remain in the business. The more profits retained in the business, the greater your access to cash. This is the quickest and easiest way to access cash when needed. It’s readily accessible and may be deployed upon your direction.
The second access to cash comes from Investment or Savings. This cash may come from you, the owner, or others, as investors. If you have historically taken distributions of cash out of the business profits and retained them in savings, they can be quickly reinvested into the business as needed. If, however, these distributions have been spent, and are no longer available, you will need to rely upon other savings or other investors to provide the needed cash.
The third source of cash comes through debt. These are loans from individuals or banks that provide access to cash upon certain terms with an expectation of repayment sometime in the future. The level of complexity and cost to access these three levels of cash increases with each level. Therefore, you want to have a cash strategy that provides the easiest and lowest cost access as possible and provides comfortably for the company needs. Much more than that will increase the cost and tempt the use of the cash for things that may not provide appropriate returns.
How Much Cash Do We Need?
In order to determine the cash needs of your company look specifically at the operational and growth needs of the company. Your company is already generating cash through the sales cycle and likely has some cash reserves for basic unforeseen expenses. Assuming that the business is operating with a comfortable cash flow, the question becomes, how much more cash should I have available? This will be different for every business, but here is a perspective to help you assess your risk regarding the level of operating cash available.
Take your annual outlay of operating expense and divide by twelve to get an estimate of your monthly demand on cash. Now multiple by three. This gives you your cash needs for three months of operation. This, in my experience provides the minimal cushion to ensure an adequate cash position in tough times. A more appropriate level is six months and for extreme comfort establish a twelve month cushion. That may seem extreme for an operational expense cushion but consider the second cash need of the organization, growth.
With a six to twelve month cash operating cushion, you have established a cash reserve that may provide for opportunistic growth strategies as well. If you wanted to expand into new geographic or product markets, embark upon a potential acquisition, or take advantage of significant bulk purchase opportunities you now have access to cash to fund the growth or provide the seed money to acquiring investors or loans to successfully accomplish your growth strategy.
What Strategies Should We Use to Manage Cash?
Given the three sources of cash presented above you should have three corresponding strategies to access each. You should have a strategy for the management of retained earnings. How much of profit should be retained versus distributed to owners? If it is distributed to owners, is there a reinvestment (cash call) expectation in the event of future cash needs?
Understanding the criteria for potential cash injections from investors (owners or otherwise) is important in preparing a strategy that positions your company to have access to investor funds. The same is true for access to debt. Your borrowing strategy should incorporate lender expectations to ensure that you’re bankable when the time comes.
Proactively managing your cash position and strategies will ensure that your business operates smoothly through challenges and opportunities. That’s why Cash is King!