Cash on hand refers to the money a business has readily available to access and use and the cash equivalents that can easily be converted to cash within 90 days. By effectively managing your cash on hand, you can ensure your business has the financial flexibility to navigate challenges and capitalize on opportunities.
Examples of Cash on Hand
The most common forms of cash on hand are:
- Physical cash and coins (including any petty cash fund)
- Checking accounts
- Savings accounts
- Certificates of deposit (CDs) where early redemption is allowed, even if a fee or penalty is charged
- Money market accounts (MMAs)
- Marketable securities with short maturities (like short-term government bonds)
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The following assets are generally not considered cash on hand:
- Accounts receivable
- CDs with a greater than 90-day maturity and where early redemption is not allowed
- Short- and long-term notes receivable
- Inventory
- Investments in stocks and bonds subject to substantial economic or interest rate risk
Importance of Cash on Hand
There are many benefits to having cash on hand, which include:
- Having a financial buffer: Sufficient cash on hand acts as a safety net, allowing businesses to cover unexpected costs or weather periods of slow sales.
- Maintaining operations: Cash on hand ensures smooth business continuity by facilitating essential payments like rent, utilities, and payroll—even during temporary cash flow fluctuations.
- Taking advantage of opportunities: Readily available cash allows businesses to seize time-sensitive opportunities, such as bulk purchase discounts or unexpected high-demand periods.
Scenario | How Having Cash on Hand Saves Money |
|---|---|
You learn from your delivery driver that their truck has gotten a flat tire mid-route. The nearest repair shop is a small business that only accepts cash. | Having cash readily available ensures minimal downtime and avoids extra fees associated with after-hours service calls or using a credit card for the repair. |
Despite your best efforts, you discover a miscalculation during tax season that results in a higher-than-anticipated tax bill. | Having a cash reserve allows you to settle the bill immediately and avoid penalties or interest charges that would accrue with late payments. |
Your office lease is up for renewal, and the landlord proposes a 10% rent increase. | Having some cash on hand lets you offer them a portion of the first year’s rent upfront in exchange for a smaller rent increase or other concessions. |
A local bakery supplier accidentally ordered too many bags of flour and offers you a 20% discount if you can pick them up today with cash payment. | Having the cash available enables you to take advantage of this deal, potentially saving hundreds of dollars on a crucial ingredient for your bakery. |
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How to Determine the Ideal Cash on Hand Amount
It’s generally recommended to maintain a cash balance that can cover three to six months of operating expenses, which provides a cushion for unexpected expenses or slow periods. Keep in mind that this is a flexible guideline, and the optimal amount can vary based on the specific circumstances of your business.
When it comes to determining the ideal cash on hand amount, we recommend that you consider the following:
- Industry: Certain industries are inherently more volatile than others. Businesses in fast-paced or seasonal sectors might need a larger cash buffer.
- Operating costs: Businesses with higher operating expenses will naturally require more cash on hand to cover them during potential downturns.
- Business size: Larger businesses generally have more operational slack and can potentially manage with a slightly lower cash reserve compared to smaller businesses.
- Interest rates: While maintaining a healthy cash reserve is crucial, keeping too much money idle can be inefficient. Businesses may want to consider longer-term investments as cash equivalent investments tend to have lower interest rates.
Let’s consider an example of a small coffee shop called Cool Beans Coffee. First, it needs to identify its monthly operating expenses. This information can be found in the accounting software or financial statements. Here are some typical operating expenses for a coffee shop:
- Rent
- Employee salaries and benefits
- Inventory (coffee beans, syrups, pastries)
- Utilities (electricity, water, gas)
- Marketing and advertising
- Loan payments
- Insurance
- Maintenance and repairs
- Office supplies
Suppose the monthly expenses for Cool Beans Coffee is $12,000. The next step is to decide how much of a buffer Cool Beans Coffee wants to have on hand. In this case, the owner has decided on a three-month operating expense reserve as a reasonable goal. This means they want to have enough cash on hand to cover their expenses for three months, or $36,000. Remember, cash includes cash equivalents, so they can invest a large chunk of this reserve in money markets or similar accounts that earn interest.
By having a clear understanding of the business’s operating expenses and setting a specific cash reserve goal, Cool Beans Coffee can make informed financial decisions. This reserve can help it weather unexpected situations, take advantage of opportunities, and negotiate better deals—all contributing to the financial health of the business.
How to Handle Cash Ebbs and Flows
There may be times when you may need additional cash or find yourself with an excess of cash. We share some ideas about how to handle these situations.
Where to Obtain Additional Cash on Hand
There are several ways for a business to obtain additional cash on hand, depending on its needs and financial health. Here are a few options:
- Increase revenue: This is the most sustainable approach. Implement strategies to increase sales, such as promotions, discounts, expanding your product or service offerings, or targeting new customer segments. Also, streamline operations to reduce costs and free up cash that can be used to build your reserves. Analyze areas like inventory management, staffing, and marketing expenses for potential savings.
- Optimize cash flow: Prioritize collecting payments from customers who owe money. Implement clear invoicing and follow-up procedures to ensure timely payments. Renegotiate payment terms with suppliers to extend your payment window, freeing up cash in the short term.
- Apply for short-term financing: A line of credit provides access to funds up to a pre-approved limit. It is ideal for covering temporary cash flow shortfalls and offers flexibility with interest only accruing on the amount used. A short-term loan can be a quick way to access a lump sum of cash. However, interest rates can be higher than a line of credit, so this option is best for situations where you can repay the loan quickly.
- Get rid of excess inventory: Review your inventory, and sell any slow-moving or obsolete products to free up cash and reduce storage costs.
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What to Do With Excess Cash on Hand
Having excess cash on hand is a good problem for a business to have because it provides a financial cushion and opens up strategic opportunities. Here are some options, depending on your goals and priorities:
- Pay down debt: The first place to apply excess cash on hand should be to pay down high-interest debt that can significantly strain your cash flow. Prioritize paying off debts with high interest rates, such as credit cards or short-term loans. This frees up future cash flow and improves your overall financial health.
- Invest in growth: Excess cash can fuel strategic investments to grow your business. Consider areas like marketing and sales by investing in campaigns to reach new customers and boost sales. Upgrade equipment to improve efficiency or invest in new technology to widen your offerings. Optimize your inventory levels to reduce holding costs and increase cash flow.
- Increase owner distributions: If you’ve spent years reinvesting earnings into growing your business, maybe it’s time to reward yourself. You might consider increasing your distributions while ensuring it doesn’t jeopardize the financial health of the business.
- Invest in longer-term options: Allocate a portion of the excess cash to longer-term investments while still monitoring risk.
- Review your cash flow forecast: Project your future cash needs to determine how much excess cash you truly have available for strategic use.
Frequently Asked Questions (FAQs)
Cash on hand is the money that a business can easily access. It includes physical cash or bills and coins kept on hand for making changes or covering minor expenses. Also included are assets that can be easily converted into cash within a short period, typically under 90 days. Examples include checking and savings account balances and marketable securities like short-term government bonds.
Cash on hand refers to all of the readily available money a business has access to, and it encompasses both physical cash and liquid assets. Meanwhile, petty cash is essentially a subset of cash on hand, a specifically designated small amount of physical cash kept on hand to cover minor, recurring business expenses. For more information, see our cash vs petty cash comparison.
There are several ways to forecast your cash flow needs. First, analyze past sales trends, expenses, and cash flow patterns. Then, develop realistic forecasts for future sales based on market conditions and marketing strategies. Finally, create detailed expense budgets for upcoming periods and use software tools to automate cash flow forecasting and analysis. Read our guide on how to create a small business budget for more information, and download our helpful budget template.
Limited cash reserves can prevent you from capitalizing on time-sensitive business opportunities. Delays in payments to vendors or creditors can incur late fees and damage your business relationships. Insufficient cash flow can also hinder your ability to cover operations expenses, leading to business disruptions.
Bottom Line
Effective management of cash on hand is important for the financial stability of any business. By understanding the components of cash on hand, determining your ideal reserve level, and implementing strong security and control measures, you can create a financial buffer and seize growth opportunities. Remember, cash on hand is a tool, not a stagnant resource. You can utilize it strategically to weather challenges, invest in your business, and achieve your long-term financial goals.
