Many companies operate day to day, week to week, assuming that the cash flow that they need to meet their expenses will arrive. However, that doesn’t always happen. All it takes is one late-paying client and you could be in serious financial trouble.
In this post, we discuss some of the reasons why your business needs a cash reserve. Check them out below.
You can’t pay your bills out of regular cash flow
Sometimes you can’t pay your bills out of your regular cash flow. That’s why high risk merchant processing often requires a reserve fund. This provides the slack that you need if your business receives an unexpected bill.
Debts that turn bad can seriously affect your enterprise. Vendors may decide to charge you interest and they could even apply to have your business blacklisted, which could make it much harder for you to get credit in the future.
You can’t pay your employees
Failing to pay suppliers is bad, but not paying your employees on time is even worse. If you don’t pay people on the allotted date that you usually do, they will begin to lose faith in your company. Some will even refuse to come into work, even if their positions are secure and your company is profitable.
Again, having a nice, large cash reserve prevents this. With 3 to 6 months of expenses in the kitty, you can absorb all these shocks without having to panic or go to creditors. It makes your business life so much simpler and actually allows you to enjoy running your firm.
You can’t pay yourself
As a business leader, you need to be able to pay yourself so that you can access all the resources you need to make your enterprise a success. But if you don’t have money in the bank, it can tempt you to forgo your own pay so that there is more left over for your business. This is a bad idea for various reasons. Firstly, it puts you under an enormous degree of financial stress which can affect your personal life. And, secondly, it can make it hard to run your business effectively. Cash reserves prevent you from running into trouble.
You can’t invest in new opportunities
Cash also provides what economists call “option value.” It’s the idea that holding onto extra cash (instead of investing it immediately) provides a kind of value in itself. You have the ability to bide your time and wait for the ideal opportunity to strike. Naturally, you can’t do this if you’re strapped for cash. So you may miss out on opportunities as the market presents them.
When building a cash reserve, try to build between 3 and 6 months of regular expenses. More than this represents too great an opportunity cost, but less than this could put you in trouble.
Only use your reserves if you don’t have any other options. You should detail the kinds of expenses that you can use emergency funds for so that everyone on your team is clear.
(Disclaimer: This content is a partnered post. This material is provided as news and general information. It should not be construed as an endorsement of any investment service. The opinions expressed are the personal views and experience of the author, and no recommendation is made.)