First off, congrats! You have a successful business under management and profits are rolling in. Time to celebrate by treating yourself to that thing you’ve had your eye on for a while, right? Wait! Before you dip into the cash that’s sitting there, take a moment to speak to a professional about how much you should take out, or how else it can be put to use.
As we’ve said many times before, cash is what keeps your company running. From paying salaries (including your own), to covering office rent, to investing in equipment, cash is what allows you to, well, make more cash. Running out of it can stop a business in its tracks.
All businesses need a strong cash flow formula to maintain momentum and growth.
A question we often get is, “How much cash do I really need to keep in the business? Our answer always starts with, “Well, it depends.”
You may have heard the traditional methodology that says keeping three to six months of operating expenses in a business is the right thing to do. This makes sense for some businesses, but it may not be the standard for others. It all depends on your business’ unique financial and industry circumstances.
Here are some things that you should consider when deciding on your cash flow formula:
- Average monthly expense: Create and review cash flow statements over the past few months to see how much you’ve been spending. Monthly amounts can vary, so take an average. Then, multiply the average by the number of months you think your business would need cash to cover expenses. Knowing how many months you need is the tricky part, and this is where a financial expert can help. They can also help keep your books updated, to ensure your calculations are as accurate as possible
- Fixed and variable expenses: Cash flow management strategies vary industry to industry based on things like purchasing requirements, equipment maintenance costs, and industry standard receivable timelines. Make sure to consider all variable and fixed expenses as part of the cash flow formula when determining how many months of runaway you may need.
- Stockpiling cash: Can you have too much cash on hand? Yes! Having a lot of cash in reserve means it’s not being used to grow the business or being invested where it can earn passive income. There’s a delicate balance that needs to be met between having cash on hand, having for expenses, and having cash to invest.
- Small business passive income: We mentioned in a previous blog post that starting in January 2019, Canadian corporations with more than $50,000 of yearly passive investment income will lose the small business deduction (SBD). Essentially, “the SBD Limit [has been] reduced by $5 for each $1 of [passive income] that exceeds $50,000 and will reach zero once $150,000 of [passive income] is earned in a year.” Consider these tax regulations when planning for how much to keep in your business versus how much to take out.
There’s no one-size-fits-all answer to determining just how much cash a business needs readily available. Each cash flow formula involves many different inputs, variables, and up-to-date bookkeeping records. What every business does need to know is that having the right financial team to determine its cash flow formula is key to keeping it moving forward and growing. Let our experienced team of CPAs be your experts.
Give us a call at 647-476-2145 or schedule an appointment.