Cash Reserves: Too Much, Not Enough or Not Sure?

Although we all know that cash flow is crit­i­cal to the suc­cess of endur­ing com­pa­nies, there are many dif­fer­ent philoso­phies around cash man­age­ment and expec­ta­tions, and a lot of debate about how much or how lit­tle cash com­pa­nies should hold onto – and what to do with it. But we all agree that when times are chal­leng­ing, cash is king.

Most well-run busi­ness­es should gen­er­ate cash — and lots of it — except for ear­ly-stage tech com­pa­nies and some very cap­i­tal-inten­sive busi­ness­es, in cer­tain phas­es of their growth.

With grow­ing com­pa­nies, there’s always ten­sion between the desire for growth and a high­er return on investment/​return on cap­i­tal and cash. And that’s how it should be. There should be con­stant ten­sion for peo­ple to prove that their invest­ments or their divi­sion of the busi­ness is the wor­thi­est for the cash the com­pa­ny has avail­able, to focus on dri­ving the best returns.

Some­times exec­u­tives are focused on, and incen­tivized to achieve, prof­it tar­gets but often at the expense of cash. We rarely talk about it until it’s a seri­ous prob­lem. In a recent dis­cus­sion about that, one exec­u­tive said,

“Prof­it is an opin­ion, but cash is a fact.”

The think­ing is that prof­itabil­i­ty can be adjust­ed. And while there are many dif­fer­ent cre­ative and legit­i­mate account­ing levers that can have a notably dif­fer­ent impact on prof­itabil­i­ty, cre­ative account­ing can’t invent cash.

How much is enough?

I’d love to give you a guide­line for how much cash to have in reserve, but I’ll just say more is bet­ter. Some CEOs like to have at least one or two years expect­ed prof­it in cash or equiv­a­lents to access if needed.

Some­times, as we work with com­pa­nies to strength­en their bal­ance sheets and build up more cash, what seems like a crazy tar­get over five years, starts to seem like we maybe went a lit­tle too low.

Jim Collins’ research in his book Great by Choice, found that many of the great, endur­ing com­pa­nies had big, fat bal­ance sheets with lots of cash.

He uses the metaphor of oxy­gen can­is­ters — stock­piles of cash — so that they don’t run out of key resources if things get weird.

The upside

In chal­leng­ing times, cash allows you to stick to your plans and your val­ues. You won’t over-react or spend all your time with your bankers, in spe­cial accounts, because your finan­cials make them uncom­fort­able, in terms of your abil­i­ty to pay in the future.

Cash also makes sure you’re well posi­tioned to move quick­ly and take advan­tage of oppor­tu­ni­ties that come your way.

The down­side

The dis­ad­van­tage of excess cash is that some­times peo­ple’s think­ing gets slop­py, and they start throw­ing mon­ey at prob­lems instead of cre­ative­ly and effi­cient­ly solv­ing them, in a way that’s that makes the com­pa­ny stronger.

How to build a bet­ter cash reserve

• Set a tar­get. A decent start­ing place is one-to-two times your pro­ject­ed annu­al prof­it, this year. If you don’t set a tar­get, there are always oth­er places for it to go.
• Put cash in a short-term account or oth­er invest­ments you can eas­i­ly access with­in 30 days. To estab­lish the val­ue of cash you can access, take the val­ue of it today and dis­count for hard times, and then fur­ther dis­count it for want­i­ng access to it quickly.

Easy access is critical.

• Talk to and teach your exec­u­tives and lead­ers about cash. Lead­ers of many great com­pa­nies are mas­ters of the income state­ment and dri­ving prof­itabil­i­ty. How­ev­er, in the orga­ni­za­tions we work with most of the senior lead­er­ship needs some help. Many lead­ers (oth­er than CFOs) are under­e­d­u­cat­ed about cash and what helps or hin­ders com­pa­ny cash posi­tion and cash flow.

You have to invest the time to under­stand where cash gets stuck in your oper­a­tions or bal­ance sheet. Oth­er­wise, growth can suck up all the addi­tion­al cash the busi­ness generates.

Some com­pa­nies’ exec­u­tive bonus­es are tied to a min­i­mum prof­it achieve­ment and cash.

• Study and opti­mize your cash con­ver­sion cycle. In many busi­ness­es we work with, we can usu­al­ly reduce the cash required for oper­a­tions by 10% or more, and put all of it back into their oper­at­ing account.

Cash con­ver­sion cycles look at your entire inter­nal sys­tem. Start­ing when you first spend a dol­lar on labour, mate­ri­als, or what­ev­er. And end­ing when the cus­tomer pays the final invoice, after receiv­ing the prod­uct or ser­vice. In the mid­dle of that whole ecosys­tem, there are often mil­lions of dol­lars of cash that is stuck. In inven­to­ry or mis­takes, cum­ber­some process­es, approvals or mis­com­mu­ni­ca­tions, or flawed think­ing in your busi­ness model.

The Chal­lenge

• Are your cash reserves where you want them to be? If not, what do you need to do to achieve your tar­get in the next six to 36 months?

Ask us about our tool set to help with your cash reserves and cash con­ver­sion cycle.

We reg­u­lar­ly work to edu­cate teams about cash flow. We help ana­lyze their oper­a­tions and bal­ance sheets to find ways to free up stuck cash.

Want more?

Lis­ten: Why You Need Cash Reserves to Weath­er Storms

Read:

What to Do with Your Cash Surplus

Prof­it Or Cul­ture First?

Oppor­tu­ni­ty Eval­u­a­tion – Pen­nies, Nick­els, Dollars

KPI Indi­ca­tors – What’s More Important?

Lawrence & Co’s work focus­es on sus­tain­able and enhanced growth for you and your busi­ness. Our diverse and expe­ri­enced group of advi­sors can help your lead­ers and exec­u­tive teams stay com­pet­i­tive through the use of var­i­ous learn­ing tools includ­ing work­shops, webi­na­rs, exec­u­tive retreats, or one-to-one coaching.

We help high-achiev­ing lead­ers to have it all – a great busi­ness and a reward­ing life. Con­tact us for sim­ple and impact­ful advice. No BS. No fluff.