Cash on hand refers to money your business has readily available to pay its costs, but how much cash on hand is enough? In this article, we explain what cash on hand means, how to understand how much cash on hand you require, and how this will help your business to grow.
Why does my business need cash on hand?
Having enough cash on hand means that your business is able to meet its financial obligations without making a loss or losing its ability to operate. This means having immediate access to cash to pay expenses, buy materials and operate without acquiring debt.
Cash reserves are also important to safeguard against the unexpected. Replacing broken computers in an emergency, recouping a defaulted payment or ordering additional stock to fulfil a larger-than-expected order are all scenarios that might call for cash on hand.
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What is a good amount of cash on hand?
In an ideal world, a typical business would keep three-to-six months' worth of working capital in the bank as cash on hand reserves. “Cash on hand is about reducing risk and ensuring the business can operate efficiently if something in the business landscape changes,” says Stefano Maifreni, Founder of the business consulting group Eggselerate. “It’s always a balancing act between ensuring the business can operate efficiently, but also manage risk.”
However, retaining a healthy amount of cash on hand isn't always viable. A survey of UK companies found that 40% of small businesses have three months or less cash on hand, and 20% of SMEs have run into problems because of late payments [1].
Determining your business’ cash needs
Depending on your particular business, you might require more or less cash on hand. “It’s more important to understand the nature of your company, the risks you face, and the likelihood of unexpected events happening,” says Maifreni.
“I would suggest looking at your revenue and operating costs over an annual period, and then making appropriate forecasts for the coming year, by quarter.”
For example, if your business relies on a smaller number of customers or operates in a highly competitive market, then there is a greater risk that costs might increase or revenue might drop, explains Maifreni. “In this scenario, the company might need access to more cash on hand to see you through slower months, or a period of time where you find a new customer or supplier, for example. I might need to rapidly adjust to changes in my market – and that means needing more access to cash.”
Companies with steady product demand and a large customer base may need fewer cash reserves. Startups could require more liquid capital than mature businesses, while firms that rely on fluctuating raw materials may need larger cash buffers.
PHC Service offers vacuum cleaner repairs at home for their 75,000 UK-wide customers. Their Managing Director, Garry Brown, tells us that his company maintains a year-long cash reserve. “We don’t tend to see many unexpected changes and we’ve been able to absorb price increases for materials fairly easily,” says Brown. “However, having cash means we’re able to invest in new technology."
How to increase my business’ cash on hand
A company could increase its cash reserves by reducing spending, though this isn't always viable. Instead, business owners should look first to their payment terms to see if there are opportunities to increase cash on hand. “You could talk to key suppliers and negotiate for better payment terms. At the same time, your own customers might be paying on 90-day terms, but you could negotiate a better offer for them on inventory in exchange for shorter payment terms,” says Maifreni.
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A common method employed by some business owners to boost available cash is to lessen the cash tied up in hard-to-liquidate assets like inventory. However, business owners should perform their calculations wisely to ensure that frequent and smaller purchases won't outweigh the benefits of reduced inventory.
Advantages of cash on hand
As well as protecting your business against the unexpected, having cash on hand to invest in a new piece of technology, for example, or taking on and honour larger customer contracts, can be highly advantageous.
At PHC Service, the vacuum repair company’s healthy cash on hand has allowed it to invest in building its own software systems to manage how engineers visit customers’ homes and record their work. “Having our own software that is quite sophisticated has allowed us to manage the engineers’ time better and spend less time on paperwork,” explains Brown. “We are also now exploring the possibility of licensing our software to other companies that do in-home service visits to customers, like plumbers or home repairs, which gives us another source of revenue.”
Disadvantages of cash on hand
Businesses need to balance keeping enough of a cash reserve and using cash effectively to thrive. Keeping too much cash on hand may not be necessary and could prevent you from using cash to invest in new personnel or expanding premises.
“It’s really a question of efficiency,” says Maifreni. “If you have capital that isn’t being used within the business, then you are not operating efficiently,” he says. “You either need to be using that money for investment in the business or taking it out as dividends.”
Cash on hand vs. cash flow
Cash on hand and cash flow are key indicators of your company's financial situation. While both relate to cash, they mean slightly different things. Cash flow is a financial statement showing how much money your business produced during a certain timeframe, reflecting the net of cash inflows and outflows. Cash on hand is the total amount of money available at any given moment.
1. Membership Rewards points are earned on every full £1 spent and charged, per transaction. Terms and conditions apply.
2. The maximum payment period on purchases is 54 calendar days and is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date. If you'd prefer a Card with no annual fee, rewards or other features, an alternative option is available – the Business Basic Card.
Sources
[1] Enterprise Research Centre, The State of Small Business Britain 2022, 2022
