Building Cash Reserves in a Cautious Economy
Businesses should develop a cash reserve strategy—but where to begin? From understanding cash reserves to securing funds, learn more with Fifth Third.
The Great Recession took nearly a decade for most industries to put in the rear-view mirror. Some companies were over-leveraged, debt-heavy, or otherwise low on cash reserves leading up to the economic downturn. As major institutions turned inward to address financial weak points, companies of all sizes began to pay more attention to their cash reserves.
With the current bull market entering an unusually long run, there's good reason to monitor your business' cash reserves. The global economy is still strong and playing host to quarterly growth, but preparing against the possibility of a slowdown is particularly important this late into a growth cycle.
And despite the continued expanding economy, there are still factors that make the future appear uncertain. Global events, such as trade negotiations and elections, can often trigger uncertain feelings for businesses.
For these reasons and more, an abundance of caution—and high cash reserves—may be particularly important in the near future.
Not all cash reserve strategies are alike, however. There are several strategies that can help you make the most of your company's emergency fund, as well as some tactics to ensure those funds are working for you.
How to Build a Cash Reserve Strategy
Every business is different, so cash reserve strategies have to be tailored to fit unique needs. Conventional wisdom recommends that businesses have enough liquid assets to cover anywhere from three to six months' worth of expenses.
To strategize your individual cash reserve needs, ask yourself the following:
How Much of a Cash Reserve Do I Need?
You may want your company to exceed this number if you anticipate certain financial disruptions as being particularly likely to harm your business, such as a rise in utilities costs, raw materials, labor, commodity prices or seasonal revenue fluctuations. Remember that you can always add to your reserves when your operating budget allows for it, and it's usually best to err on the side of caution when it comes to saving for emergencies.
What Risks Do I Need to Hedge Against?
As you build your company's cash reserves and think about your overall strategies for dealing with potential economic and financial disruption, take a closer look at your current spending habits as well. If there are areas where cost-cutting makes good financial sense (and won't hamstring your ability to grow your business in the process), consider trimming expenses where possible. This can help your cash reserves stretch further. Plus, taking stock before emergencies arise will help you make smarter decisions.
Another helpful way to beak down your cash reserve tactics is to think in blocks of time when putting money aside. Break down expected expenses and cash contributions into short-term emergency needs, medium-term requirements, and the kind of cash you'll need to have on hand for long-term issues. You may have fewer high-priced expenses in a three-month period than you might in a half-year or year-long downturn. Better to prepare for these different scenarios now than to underestimate the liquid assets required to see things through.
What Are My Goals?
Your company's strategy for building cash reserves could (and should) be different than that of other businesses—even your competitors. Every business has different objectives, and therefore has different needs for capital to go alongside them.
For example, if you want to grow your business in the next two to five years, the amount of cash you'll need in reserves may be higher as you hedge against losses due to expansion (such as low-performing goods or underperforming locations). If your business is heavily invested in the stock market or derivatives, you may also want to think about your current exposure and how market moves could impact your cash reserves as well, picking a portfolio with the right amount of risk for uncertainty ahead.
How to Build Wealth with Cash Reserves
The idea of keeping liquid assets on hand for emergencies may seem at odds with investing cash in order to earn interest. These two objectives, however, aren't necessarily in opposition. In fact, it's still possible to maintain liquidity while also growing your emergency fund. There are several account types that can act as a safe place to store liquid assets while also giving account holders a modest return on their investment.
Perhaps unsurprisingly, strong options worth considering to invest a company's cash reserve are within more conventional options that put liquidity at the fore.
1. Business savings accounts and money market accounts offer quick access to cash while still providing companies competitive interest rates on their deposits. These investments may not yield as much of a return as other options, but there's also less exposure to a market downturn or a loss in investment value. After all, your cash reserves are meant to be handled conservatively, thus the places where you park your cash should be more risk-averse as well.
2. A Certificate of Deposit (CD) account is another liquid savings option that can help earn interest while providing a safe place for cash reserve deposits. With CDs, an account holder is provided with a set interest rate in exchange for keeping the funds in the account—but keep in mind withdrawal outside of the set time period will carry a penalty.
Building cash reserves is critical for any business, especially as financial uncertainty seems to linger. Even during bull runs, companies still need to stash away more than the minimum operating cash needed to withstand a down month. By having ample cash reserves, you can safeguard against economic headwinds or unforeseen issues with your business. And, by investing this cash in a way that preserves liquidity but still generates interest, you can help grow your funds without sacrificing quick access to your money.