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How do you handle your cash reserves?

Here comes some advice for all of us to use in business or in our personal lives.  But to understand it, we need to delve into the short-and long-term sources and uses of cash.

Good cash strategies to remember

It is tempting to use available cash in good times to build the business and in challenging times to pay the bills and even to outdo competitors in marketing efforts.  Those are both good strategies.  But there is a tactic that we need to remember that just might save us someday.  And it has application to our personal lives as well.

The rule of cash reserves

For our businesses: Once a business has achieved break even and beyond, it should build a cash reserve equal to at least two months’ worth of fixed overhead to protect against unexpected internal or external emergencies, and to allow for your relatively restful slumber at night rather than worry about cash balances.   For our personal lives, the same rule applies, with two months’ reserve should be an absolute minimum.

Protecting our “sticky cash”

It’s a good practice to keep that reserve, which we’ll call “sticky” cash, in a money market account, not because of its earnings potential, which is usually so small as to be inconsequential, but because it is visible and requires effort to invade the balance.

How about seasonal businesses or seasonal work?

[Email readers, continue here…]   Seasonal businesses and seasonal personal work are more challenging, and maintaining “sticky cash” is even more important, since it must see you or the enterprise through the low times, long or short. For seasonal sources of income, short term bank loans are an ideal way to augment cash flow and for businesses to finance receivables during high season, always assuming that the loans will be paid off in full – from seasonal receipts.

Matching a loan term against use of funds

If borrowing from a line of credit or any of several forms of loans not specifically created for long term repayment, never use those borrowed funds to buy assets or pay down long-term debt.  You will be mixing your short-term asset (cash from the loan) with long term payments.  Tempting as that is, the practice – even if used once – can lead to trouble when it comes to repayment of the loan.  Always match your borrowing term against your use of funds.  And a line of credit should always be considered short term.

Loans for major asset purchases

On the other hand, an extended loan for purchase of a building, car or working asset, should have a repayment term that extends into years of interest and principle payments to match the life of the asset or prevent drain of working capital.

So, remember the source of your cash on hand. And remember the need to maintain reserves, and how to protect them by isolating those reserves in a money market account. And maintain those disciplines always to protect ourselves during hard times to survive the downturns that hit most of us at some unpredictable time in our business and personal lives.

  • This concept is how I originally stumbled upon (as my team refers to you) “The Wizard of Berkus”! When a person queries short term vs long term capital you are still the only reference that appropriately addresses this seemingly complex issue that kills small business owners, especially in the critical startup and early growth stage. Lines of credit and customer deposits are harbingers of bankruptcy if used for long term assets that are not capitalized appropriately. I can tell you all from personal experience that not wanting to pay term interest, speculated success/profits, ignorance to cash flow, or inability to justify the purchase of long term assets to your banker are all invalid reasons to cross the line between eating up your (cash) resources and gaining a strategic asset. Thanks again Mr Berkus for publishing this valuable information!

  • Hi Dave, I love this. Such simple, real world advice, not only for business owners, but EVERYONE. While I have been teaching the same thing for decades, it is even stronger when it comes from and investor of your stature.

  • Dave as always thanks you for a great article. I like the idea of cash reserves but I’ve been told I have to pay taxes in order to retain that money in a C corporation. What are the tax consequences of keeping two months cash reserves and is there someway to avoid paying taxes on this to retain the money within the corporation

    • Bill,
      You are right that tax is paid on income whether on a cash or accrual bases. So reserves are taxed when earned. But when later spent, the opposite effect offsets the earlier tax as business expenditures are made with that money…

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