Happy Saturday!
Today we’re talking cash. Specifically, cash in your business. How much is too little, how much is too much? Let’s look at:
- What factors impact your cash needs
- How to land on a number (plus a free template)
Let’s do it!
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You don’t want your business to run out of money. That much is obvious.
But what’s wrong with too much cash in the bank?
Think of it this way: cash sitting in the bank could be better used in the business. Anything beyond your ideal balance is like leaving your foot on the brake pedal.
So how do you find that “ideal balance”?
The popular rule of thumb is “3 to 6 months”. And this is a helpful starting point.
But the real answer is: it depends on your business.
Let’s look at eight factors that should dial your estimate up or down, then I’ll give you my Cash Projection Template.
Cash Balance Considerations
1. Is your business seasonal?
If expenses and revenues are concentrated in a few months, you should keep six months of expenses or more in the bank.
2. Is your business new?
New businesses have fewer benchmarks and more uncertainty. If you’re two years old and closer to $500K annual revenue, you should aim for more reserves than a business that’s been doing $3M/yr for the past decade.
3. Do you have access to a line of credit or loans?
SBA 7(a) loans are great, but they take time. If you need money quickly, what other options do you have? Quicker access to cash usually comes with higher cost (interest rates or otherwise).
4. How large is your client base?
This is about determining volatility. The more diversified your revenue sources, the less impact losing a client will have.
5. How confident are you that your clients will stay?
Will your clients be here tomorrow, next year, or five years from now? With questions like this, it’s very easy to buy into your own story — ask yourself: how do you know? Can you get a second opinion?
6. What are your growth plans?
If you plan big purchases over the next 12 months, keep more in cash reserves. If sales are expected to row, how much cash do you need to fuel the flywheel? Do you plan to hire soon?
7. Industry and economic trends
What’s coming up, big picture, for your industry? What are your customers doing? And look to history: what typically happens to your industry during downturns?
8. How liquid are your assets?
The more liquid you are, the less cash you’ll need.
Now that you’ve considered the factors above, it’s time to talk turkey.
How to pick a number
1. Define your monthly costs and expenses.
Pull up your previous year’s income statement.
Go through each expense line and estimate what you think you’ll spend on it per month in the coming year.
Then calculate your average monthly production costs based on average monthly sales.
You can use this template (courtesy of my company Scalepath!) to estimate your company’s cash-on-hand requirements.
The template has different tabs for two models:
- If you’re a non-seasonal business, or want a simple cash projection, use the “Average Monthly Cash Projection” tab
- If you’re a seasonal business, or want a detailed cash projection, use the “Whole Year Cash Projection” tab.
2. Decide what number is best for your business.
This ultimately comes down to:
- The output from the provided template…
- Adjusted to your business plans for the next 12 months…
- Adjusted to your comfort level.
If the number seems crazy high, don’t panic.
At the very least, you can use the cash projection as a benchmark to work towards.
3. Revisit regularly.
This is the step many people miss. Your cash needs will constantly evolve, so book it into your calendar to come back every quarter and revisit your cash reserve projections.
This will give you a chance to compare the actual numbers to your estimates, and adjust accordingly.
You’ll also want to track:
- How quickly you receive your cash
- Inventory turnover in days
- Accounts receivable in days
- How often you make payments to vendors
This will give you a sense of how quickly your company can convert cash into inventory, and vice versa. Tracking this is called a Cash Conversion Cycle (CCC).
As you practice this, your projections and actuals should move closer and closer together.
Here’s the template download again, if you missed it before:
Download the Cash Projection Template
A final note
Now that you’ve made a cash projection… do it two more times.
I always recommend projecting a best, worst, and base-case scenario.
It’ll work your optimism and pessimism muscles, and you’ll learn a lot by seeing where your actual numbers land.
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This playbook comes courtesy of Scalepath, one of the companies I've incubated!
Scalepath is a Peer Advisory Network for Growth-Oriented Small Business Owners.
Building a small business is lonely. Work through your toughest challenges with those on a similar journey. Membership overview:
- Peer Advisory Groups
- Online Community
- Playbooks and Templates
- Speakers and Events
Only for Small Business Owners doing $500K - $7M. Learn more at joinscalepath.com
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3 things from this week
- Appetizer: I made a video last week on the 11 Mistakes to Avoid When Buying Businesses. Everything from fishing expeditions, to macro red flags, to buying yourself a job. What would you add to the list?
- Main: We’re hiring a Head of Podcast Strategy here at Girdley Media. So I made a promo video and got my staff to roast me. It was brutal. Give it a watch! (Twitter/X)
- Dessert: “Have you given up on this project?” These are magic words when someone isn’t getting back to you. Until this week, I’ve had a 100% success rate. But it failed me for the first time. What should I try instead?
I still highly recommend the book I got this from: Never Split the Difference, by FBI hostage negotiator Chris Voss.
That’s all for this week!
Michael
