07/04/2022
How to Calculate How Much Cash a Company Needs
Every business is different. Some businesses need at least six months of expenses in cash on hand, while others need only three or four.
So, how can you know how much cash your business needs?
The first thing to figure out is what your costs are every month. For some businesses, this is easy – just look at your expenses for the past 6 months, add them together, and divide that number by six.
However, it gets a bit trickier if you have a seasonal business. For example, if you sell Christmas trees, you can’t calculate your expenses from February to July to determine your monthly expenses.
Similarly, if your business is new, you’ll have to deduct startup expenses that only applied the first few months. The same applies to one-time expenses like building renovations.
The next factor to consider is the percentage of those expenses that aren’t truly necessary. If you can cut expenses and still operate on a profit (or without a loss), those expenses don’t need to be included in your monthly total. If an emergency arises, and you need to rely on your cash reserves to keep you afloat, you can cut those expenses.
For example, you may be able to lay off some workers and still operate at a decent level of productivity.
There are other factors you must take into account as well.
If your business has excellent credit and you can get a quick retail store business loan with low-interest rates at any time, you might not need as much cash in hand. If you have assets you can quickly sell, the same applies. In addition to the liquidity of your assets, consider whether they are appreciating or depreciating.
Similarly, if you can get a merchant cash advance, you can take the advance into the equation when determining the ideal cash-on-hand amount for you. (Read: How does a merchant cash advance work?)
If your cash flow forecast is pretty healthy for the next couple of months, you may also be able to get away with less cash in hand. Nevertheless, don’t rely on that – you need to be conservative when forecasting future cash flow and consider the worst-case scenario.
Industry forecasts can also help, but if Covid-19 has taught us anything, it’s that we can never know what will happen.
Finally, the nature of your business is significant as well. If you operate a currency exchange office, you need more cash on hand than if you offer HVAC repair services.
