Picture this scenario. There’s a downturn in the economy. Your two biggest clients tell you they have to cut spending and can’t work with you anymore. And while you still have some projects on the go, you know you won’t be paid for at least a few more months. If this train of events were to happen to you, would you have the business cash reserves to see you through? Or would you be laying off staff within days?

A recent survey of UK businesses found that a full 22% of small firms have no savings at all, while two-fifths hold less than £1000 in their business cash reserves. Let’s look at why you need business cash reserves and work out how much you’d need for a rainy day.

Why you need business cash reserves

It’s obviously sensible to have money saved up for the kind of ‘rainy day’ scenario outlined above. But, there are other reasons you need healthy business cash reserves too:

  • Better credit rating

If you have tens of thousands of pounds saved up in your account, you’re likely to have a better credit rating, and banks will be more confident lending to you.

Read our blog on what you need to bring when applying for a business bank loan

  • Bridging cashflow gaps

You may well have projects signed off that are worth hundreds of thousands of pounds. But until you get paid, you won’t be able to pay your staff. Having business cash reserves allows you to keep paying employees until your clients pay up

Read our blog on managing cashflow

  • Unexpected tax and fines

Everyone makes mistakes! If you’ve miscalculated the amount you need to pay in tax, or receive a fine of some sort, having business cash reserves helps you weather the storm. Working with highly experienced accountants makes this much less likely

How much business cash reserves do you need?

A general rule of thumb is that you should have enough cash saved up to cover 3-6 months’ worth of expenses. That said, there are huge variations between companies and the amount of business cash reserves you will need.

For example, if you’re a sole trader who works from home, your expenses will be drastically lower than a small-scale manufacturer who employs ten staff, rents a workshop and specialist equipment. Many sole traders can cut their personal spending too, so depending on what their rent and basic expenses are, they might need as little as a thousand pounds to see them through a couple of dry months. Our manufacturer might need up to £50k.

Here’s how to calculate the amount of business cash reserves you should set aside:

  • For established businesses

Look at your monthly cashflow reports for the past year and work out your average monthly expenses. You should look at your future cashflow projections too and think about your general plans – if you expect to hire three more employees this year, take those expenses into account.

  • For new businesses and start-ups

Refer to your business plan and your projected expenses, cash flow and balance sheet (read our blog on business plan financials for more detail). Be conservative here and estimate your expenses for the ‘worst-case scenario’.

Remember that there will be variations in your expenses throughout the year – you might attend an expensive industry conference in June, for example, or hire lots of temporary staff in December – your reserves should be large enough to cover these more expensive periods. It’s also worth underscoring that your expenses will rise dramatically if you start growing fast. Your cash reserves therefore need to expand to adjust to this change.

Business cash reserves example

Lucy runs a direct-selling business which specialises in the weddings market. She has two permanent employees – one who runs the admin and marketing side of the business, and another who helps Lucy with sales. For the six-month-long high season over spring and summer, Lucy hires temporary workers to help manage stock and the uptick in demand. Lucy’s average monthly expenses are:

  • Salaries: £5000 in the low season, £7000 over spring and summer
  • Rent: £0 during the low season (she stores goods in her garage), £500 over the busy months when she uses a warehouse
  • Travel: £300 in the low season when she’s visiting a smaller number of customers and stockists, £1000 per month over summer

Because she’s fairly conservative, Lucy saves up enough so that she’ll be able to cover all her expenses for at least three months during the high season – a total of £25,500. This amount also means she’s covered for almost five months during the low season too.

Building your business on solid foundations

Setting aside money from the profit you make offers so many benefits. You aren’t dependent on lenders to see you through dry patches and you have the peace of mind that, should anything go wrong, you’ll be able to pay yourself, your staff and for all your other expenses until things pick back up again.

Talk to our friendly team of accountants today to learn more about how much business cash reserves you should be saving and the best way to do it. Contact us here.