Properly managing cash flow and working capital is essential for the success of any business. While larger companies may have access to more financial resources, small businesses’ resources are often limited. While holding as much cash as possible seems like a logical solution to potential cash flow problems, keeping lots of excess cash on hand may actually be detrimental to your business. Smart business owners try to strike a balance between maintaining necessary cash reserves and hoarding too much cash.
Missed Financial Opportunities
One of the most significant potential disadvantages to holding excess cash can be the opportunity cost of hoarding cash. When you hold onto cash, you can lose some of that cash’s purchasing power because of inflation. Cash held in a business checking account or even in the form of certificates of deposit or short-term bonds rarely generates enough interest to overcome the loss of purchasing power from inflation. It’s a low-risk option, but it also gives you little reward, unlike other investment options that come with higher yields.
You also miss out on the potential for additional revenues you might generate by investing excess cash on hand into growing your business. Instead of putting the money in a checking account earning only 1% to 2% interest, you can invest that same cash into expanding your business, which could generate a return of 25% or more.
Careless Financial Decisions
Holding excess cash can lull you into a false sense of security that may lead to careless spending. That feeling of overconfidencemight cause you to commit cash to projects without adequate market research. When you have a tighter cash flow, you may be more likely to think through your spending more carefully or keep your costs lower. When you have a large cash reserve, you may ignore rising costs. It’s simple human nature that the more money people have, the less care they tend to exercise in managing it and the more extravagant they tend to be with expenses.
Interest Payments on Debt
The price you pay for taking on business debts is interest payments. Instead of paying interest on loans and other debts, use the excess cash you have to make purchases outright rather than running up more debt. You end up with less cash on hand, but you also save your company money by cutting out those interest payments. You also have the assets that you purchase, which you can sell for cash if your business gets into a tight financial situation.
Pressure From Partners or Investors
If you have a partner in your business, having excess cash on hand can cause conflict if the two of you don’t agree on whether to hold onto it or invest. Your investors may want you to put that money back into the business to help it grow. Feeling that pressure from different sides adds stress to your plate and can create a difficult work environment.
Advantages of Holding a Cash Reserve
Businesses should maintain enough cash reserves to handle temporary downturns in revenues or slow-paying customers. Many business experts recommend keeping three to six months of operating expenses in the form of cash on hand or assets that can be converted to cash quickly. The amount of cash reserve your business should maintain depends at least partially on the nature of your particular business. Is your business seasonal with long periods of little income? How vulnerable is your business to a general economic downturn? Considering such questions can give you a better idea of whether you need to keep a relatively smaller or larger cash reserve.
Manage your cash flow by having a clear idea of your current expenses and potential near-term unexpected expenses, and maintain a good feel for the current and likely future condition of your marketplace. While keeping some cash in reserve is important, it’s also important for the growth and continued success of your business to put available capital to work in generating additional business revenue. 4.3 million customers use QuickBooks. Join them today to help your business thrive for free.