The primary goal of almost every business, except for not-for-profit organizations, is to generate profit. Surprisingly, making money is often the easier part; the real challenge lies in effectively managing and preserving those funds. With various expenses such as vendor payments, supplies, employee salaries, and personal compensation, it’s common for businesses to break even or struggle to maintain a healthy cash flow. But is this the most optimal approach to running a business?
Before we dive into this topic, it’s important to note that we are not financial or tax experts. We strongly advise consulting with your accountant or financial department before making any changes to your financial practices. With that being said,
Finding the Balance
Many small businesses, in an attempt to minimize taxes, strive to zero out their balance sheets at the end of each year. Unfortunately, some take this practice to the extreme, maintaining low bank balances throughout the year. According to a study by JPMorgan Chase, the average small business only has enough cash on hand to cover 27 days of expenses. This approach can be risky, especially when major purchases or seasonal fluctuations in the industry are involved.
Financial experts often recommend having enough cash reserves to cover three to six months of expenses. While this guideline is beneficial, it may not be feasible for every business. Industries such as construction, for instance, often face material costs that far exceed their payroll expenses, making it challenging to adhere to a six-month reserve plan. So, how do you determine what is reasonable for your business?
Embrace Your Inner Nerd
You may have noticed that we didn’t promise an article without any math at the beginning. However, fear not; we’ll make this as painless as possible. Before arriving at a specific figure, consider your goals and previous experiences. For seasonal businesses, analyze the months of excess versus the lean periods. If your workload remains steady year-round, are you planning to expand your workforce or make significant capital investments? For the first scenario, calculate your average monthly income minus expenses and multiply the result by the desired number of months to cover:
[Monthly Income – Monthly Expenses] x Months to Cover = Required Cash Reserve
It’s as straightforward as that!
Adjust the calculation for the second scenario to take the estimated investment amount into account and divide it by the number of months you have to save.
[Monthly Income – Monthly Expenses + (Total Investment / Months to Save)] x Months to Cover
This calculation may seem slightly more complex, but with the guidance of a financial professional, it becomes manageable. To make things easier, you have two options. The obvious one is to increase your gross income, which is always beneficial. The other option is to reduce expenses. What are some effective ways to achieve this?
Mitigate Costly Oversights
Efficiency directly correlates with cost reduction. However, there are hidden costs that many small business owners tend to overlook. While it may seem tempting to cut employee salaries to save money, this approach can backfire in the long run. In the current job market, employees have numerous alternatives available at their fingertips, thanks to the internet. Losing a valuable employee due to minor pay discrepancies can result in the loss of their productivity, which can far outweigh the salary savings. On average, replacing an employee can cost up to a third of their salary out of pocket!
Another common mistake is neglecting to plan for technology-related expenses. While businesses often invest in various insurance policies for protection, technology infrastructure is frequently overlooked. Consider this: If your system goes down or requires an upgrade, how much will you need to spend, both out of pocket and on potential downtime?
Unfortunately, many businesses fail to incorporate these critical factors into their budgeting process, leaving them vulnerable to significant financial setbacks. This is where a Managed Service Provider (MSP) can serve as an insurance policy for your technology needs. An MSP assesses your requirements and goals, devises a monthly plan, and ensures that you won’t encounter any surprises when faced with known or unknown technology demands. By including MSP services in your monthly budget, you can focus on growing your business without worrying about technology-related disruptions.
The Value of Effective Cash Flow Management
Maintaining a reasonable amount of cash on hand empowers your business to navigate uncertainties and flourish. With the information provided, take the time to assess your current financial standing and determine the best course of action for your business. If you’re interested in exploring how an MSP can enhance your liquid cash reserves, feel free to contact us directly.
