What are cash reserves?
Cash reserves are savings to be used in an emergency, i.e., when unforeseen business expenses occur or when cash receipts from sales decline. Generally, cash reserves are maintained in a separate bank account, segregated from the money you use to run your business.
Why are cash reserves important?
All businesses experience unforeseen events, such as declines in sales, customers paying over time, and/or unexpected repairs and maintenance. Having a cash reserve allows your business to cover its operating expenses during these times. If your business does not have a cash reserve, you may have to obtain financing via credit cards or a financial institution.
How much should you keep in your business cash reserve?
A general rule is for businesses to maintain three to six months of its operating expenses and any debt service payments in a segregated bank account. Operating expenses include payroll and payroll taxes, insurance, retirement plans, advertising, vehicles, office rent and supplies, professional fees, income taxes, utilities, etc. Debt service payments include business, vehicle, and equipment loans. This information can be obtained by reading your business’s financial statements, specifically the statement of income or loss, along with your cash flow statement.
How to create a cash reserve
Setting up a cash reserve is best achieved through the budgeting process. Many businesses prepare an operating budget for the upcoming year. Once you have calculated your desired cash reserve, include a line item in your budget for transferring these monies from your operating account to a segregated savings account. It may take six to twelve months for your business to achieve its cash reserve goal, but by budgeting for it monthly, it will become measurable.
Tom Vignali CPA, Inc. assists businesses with calculating cash reserve requirements and budgeting. Should you need assistance, feel free to contact us.
Contact Us:
Thomas W. Vignali CPA Inc.
118 Point Judith Road
Narragansett, RI 02882
T: (401) 415-0798
tom@tomvignalicpa.com
www.tomvignalicpa.com
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