How Much Cash Should Your Business Have?

Key takeaways:

• There’s no one-size-fits-all cash reserve for small businesses; the right amount depends on factors such as operating expenses, cash flow, seasonality and business-specific risks.
• A common benchmark is three to six months of operating expenses, but your business may need more or less depending on how predictable its revenue and expenses are.
• Keeping cash reserves separate from everyday operating funds can make it easier to track and protect money set aside for unexpected expenses.

As a business founder, Dmitrii Malashkin says one of the biggest financial lessons he has learned is often overlooked: Don’t lump all your cash together.

“I used to use my checking account like a single pot of money—for bills, savings and setting aside money for business growth—which made me blind to both emergencies and opportunities,” says Malashkin, the founder and CEO of Born to Move, a moving company in Boston.

It’s a balancing act many small business owners face. You need enough cash on hand to cover ongoing expenses and handle the unexpected, while also considering how much cash to set aside for other business priorities.

Here’s how to understand how much cash your business needs, what can affect that target and how to manage reserves as your business changes.

How much cash should a business have?

Every small business has different financial needs, so there’s no universal amount of cash to keep on hand. The right level of operating cash and the amount you set aside for a small business emergency fund depend on your expenses, cash flow, and other business-specific factors.

A good first step is to calculate how much it costs to keep your business running each month. Start by adding up essential ongoing expenses such as:

• Payroll
• Rent or mortgage payments
• Utilities
• Insurance
• Debt payments
• Taxes
• Inventory or supplies necessary to continue operating

Tip: Use Fifth Third’s Business Expense Calculator to help you tally the total.

Next, consider how long you’ll want to be able to cover these essential expenses if revenue slowed or an unexpected cost arose.

“You’ll often hear the rule of thumb that you should have three to six months’ worth of operating expenses put aside,” says Kay Whitaker, cofounder and managing director of an accounting firm in Fishers, Indiana. “I think that’s a useful reference point, but I wouldn’t automatically apply it to every business. The important thing is that the reserve is intentional.”

Understanding operating cash, working capital and business emergency funds

When determining how much cash your business needs, it helps to distinguish between three related—but different—financial concepts:

• Operating cash: This is money available to cover your business’s recurring, near-term expenses, such as rent, utilities and payroll.
• Working capital: This difference between your business’s current assets and current liabilities can be an indicator of your ability to meet short-term financial obligations. Calculate your working capital by subtracting current liabilities from current assets.
• Emergency fund: This is money intentionally set aside to cover unexpected costs, such as an equipment breakdown or big repair, or to help pay bills when revenue falls short.

These terms are related, but they are not interchangeable. For example, $5,000 in a business checking account may serve as both operating cash and an asset that would factor into your working capital. Working capital can also include assets that aren’t immediately available as cash, such as inventory or accounts receivable.

Factors that determine your business cash reserve

Forecasting can help you determine how much working capital your business needs by anticipating cash flow needs and preparing for expenses outside your regular monthly budget. Understanding working capital for small business can also help you plan for short-term obligations and unexpected costs.

“The biggest threat will most likely be several small, unexpected expenses piling up—not one big expense,” says John VanDerLaan, founder of Golf Gear Advisor in Naples, Florida. “Aside from the big quarterly numbers, one of the most important forecasts is a week-by-week basis look at the next couple of months.”

Here are several factors you should review to help you better understand how predictable—or unpredictable—your actual business cash needs are.

Keep in mind that every business should weigh these factors differently. Seasonality, for example, might be top of mind for a business based in a tourist location, while it might be less important to a business with a steady year-round clientele.

“If you understand your run rate and your cash flow drivers, you can model different scenarios before they become problems,” Whitaker says. “You know where you have flexibility and where you don’t.”

How to build a business cash reserve

Once you have a target, build your cash reserve gradually with a consistent savings strategy. Setting aside funds regularly in a dedicated business savings account can help you grow your reserve over time while keeping it separate from everyday operating cash.

Potential strategies include:

• Setting aside a consistent portion of available cash every month
• Saving more during higher-revenue periods, particularly for seasonal businesses
• Automating transfers into a separate reserve account
• Directing unexpected or above-forecast revenue toward the reserve when appropriate
• Replenishing the reserve after you need to use it

It’s also a good idea to plan for predictable large expenses in your regular budget so you don’t have to rely on emergency reserves to cover costs you knew were coming.

Types of accounts to keep your savings in

Where you keep your cash reserves should depend largely on how quickly you may need to access the money. Separating reserves from everyday operating funds can also make it easier to track what you’ve saved and avoid using that money for routine expenses.

Short-term reserves:

• Prioritize liquidity and easy access for money you may need quickly.
• A business savings account linked to your business checking account may make it easier to move money when needed while keeping reserves separate from operating cash.
• Compare factors such as fees, minimum balance requirements, withdrawal or transaction limits and interest rates.

Longer-term reserves:

• If you have cash you don’t expect to need immediately, you may be able to consider options that trade some liquidity for the potential to earn more interest.
• Depending on your needs, options could include business money market accounts or certificates of deposit.
• Before committing funds, consider when you’ll need the money and any restrictions or penalties associated with accessing it early.

What to know about cash flow management

Maintaining a cash reserve that suits your business’s needs is only one part of effective cash flow management. Regularly monitoring the money coming into and going out of your business can help you anticipate potential shortfalls rather than simply react to them.

Some ways to stay on top of cash flow include:

• Track accounts receivable and know when customer payments are expected.
• Plan for recurring and seasonal expenses so predictable costs don’t catch you off guard.
• Compare actual cash flow with your forecasts regularly and investigate meaningful differences.
• Consider the timing of expenses rather than focusing only on how much your business spends.
• Review your reserve target as your business changes, particularly after meaningful shifts in revenue, expenses, staffing or other operating needs.

Malashkin incorporated a three-bucket strategy for his business, separating his funds into operating cash, emergency cash and strategic cash. “That system helped our business capitalize on two major expansion opportunities and cover a $24,000 unexpected vehicle repair bill without going into debt,” he says.

Whatever approach you choose, the goal is to give every dollar a purpose. Thoughtfully managing your business cash reserves can help ensure the money you need for operating expenses, emergencies, and future opportunities is there when you need it.