As an entrepreneur, enjoying a peaceful night's sleep can often seem like a rare luxury. The primary culprit behind these sleepless nights typically revolves around cash flow concerns. Questions such as "Will I have sufficient funds to meet payroll?" and "Do I possess the necessary capital for business expansion?" are common anxieties among our clients.
So, how much cash is truly adequate? Our response is grounded in data analysis. After scrutinizing the cash flow cycles of numerous businesses, we've identified a recurring trend. The lowest point in the cash flow cycle typically hovers around two months' worth of direct labor and operating expenses. This readily available cash can often shield a company from most cash flow challenges. We also recommend maintaining access to a line of credit, although our preference leans towards maintaining a zero balance.
It's important to note that exceptions to this guideline exist. For instance, if your clients prepay for services, you might be able to manage with slightly less cash on hand. Conversely, if you extend payment terms beyond 30 days, you may find it prudent to maintain a larger cash reserve. Understanding your business's capital requirements for growth is crucial, a concept we refer to as Trade Capital, which we'll delve into more deeply in a future article.
Additionally, it is possible to have an excess of cash within your business. The primary concern here is the exposure of excess cash in the event of legal action. However, we have observed another, often riskier issue associated with carrying an abundance of cash – it tends to impede decision-making. In economic downturns, businesses with minimal cash take immediate action because they have no other option. Given their ample cash reserves, entrepreneurs often adopt a more cautious 'wait and see' approach when a company has an overabundance of capital. This delay in decision-making typically exacerbates the situation.
To ensure a better night's sleep, it's essential to right-size the amount of cash in your business. The Simple Numbers Team is here to help if you need assistance in achieving this balance.
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