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?

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