Cash is key for small businesses. It helps you pay your employees and suppliers when profits are slow or keeps things on track when clients are slow in paying you.
Steady cash flow is not only crucial when times are tough, however. It can also be used to help your business grow and develop, acting as a vital cash injection to push your SME into the next stage of growth.
Generally, the best time to fund your SME if you need additional finance through something like a business loan is when you don’t need it. Acting with precaution and having ‘emergency’ funds in the bank gives your business breathing room for any low periods and helps you recover more quickly.
Many UK small businesses are now in the Golden Quarter, where sales and profits are boosted thanks to the Black Friday, Cyber Monday Weekend and the run up to Christmas. Maintaining a steady cashflow is more important than ever, so now is the perfect time to find out what works best for your SME.
However, working out what your small business needs, and even how to obtain the cash, can sometimes be tricky. To get you started, there are some general rules of play and questions to ask yourself.
What are my business outgoings each month?
Step number one is to get clued up on your monthly expenditure. By working out how much your SME needs to spend on average each month on things like rent, utilities, and other inventory costs, you can devise a plan for how much you need to keep in the bank in case of emergency or plans for growth.
Working out your monthly operating expenses can be easier said than done, however. How much you spend per month varies across different industries, and of course there can be seasonal variations that also impact cash flow.
How to work out your monthly operating expenses
Whether your expenses are typically quite consistent throughout the course of the year or not, there is a simple process to follow to work out your monthly expenditure. Use your accounting software or bank account statements to help:
- Take a look at your cash flow statements from the past 12 months (this will take into consideration any seasonal variations)
- Work out how much you spend each month (note down the biggest spending month as this will be useful to know for the future)
- Add all these together, divide by 12 and this will give you your average monthly expenditure
If you’re a seasonal small business, for example an eCommerce business selling sunglasses, it means your expenses will likely be more concentrated in certain months aligned to your sales. It’s important to know when these times are, which is why using a period of 12 months is so beneficial.
How much should my business have in the bank?
Some business experts suggest having three months of operating expenses in the bank, others suggest six. The main thing to remember is that you should feel comfortable and not under any strain in creating this reserve, which can often depend on the personality of each business owner.
Although having a healthy reserve of cash in the bank can support your business through tough times, it’s not the be all and end all. In fact, having an extremely large reserve in the bank can actually be a waste of funds that could be invested more efficiently back into your business.
The best approach is to tailor your cash reserves to meet your business’ specific needs. Look at your small business’ 12-month trajectory and carefully work out your future goals and plan out your forecasts.
If the plan is to expand your business, having a large quantity of cash just sitting in the bank could be exactly what you need. If you’re a more established business, you might feel more comfortable keeping a healthy reserve just in case you encounter any hiccups over the year. Either way, making sure that you have money in the bank and positive cashflow running through your business is what every SME should strive for.
How do I calculate my ideal cash reserve?
Once you know how much cash you spend each month and how much you will need moving forward to support your business plan, you can work out how much to keep in the bank.
This is calculated slightly differently depending on if you have steady monthly operating expenditure or costs that fluctuate. Follow the process below to work out how much your small business should keep in the bank.
How much cash should my business have in the bank – non-seasonal businesses
If your business’ monthly expenses remain fairly consistent throughout the year, multiply your average monthly costs (calculated earlier) by either three or six, dependent on how many months you want in your reserve.
For example: If your average monthly expenses are £30,000 and you want a three-month reserve, your sum would be: £30,000 X 3. Therefore, making your cash reserve £90,000.
How much cash should my business have in the bank – seasonal businesses
Like with working out your average monthly spending, if you run a more seasonal business the equation is a little different. You need to be saving enough to cover your one high month, but also those regular months in between.
Take a look at the following example to work out how much money to put in the bank as a seasonal business:
Say your high-cost month is £100,000, your regular months are £20,000 and you want a three-month cash reserve.
- Multiply £20,000 by two months to get the total for the first two months = £40,000
- Add the £100,000 high-cost month
- Your total of £140,000 is your three-month reserve, which ensures a strong cash flow for one high month and two regular months
How do I build a cash reserve for my business?
Once you’ve worked out how much cash your small business needs in the bank, the next step is to start building your cash reserve. There are lots of ways you can do this, which include:
Self-financing for SMEs
One option is to simply put money away each month from your income. Transfer a certain amount of your profits to a separate bank account or a savings account each month until you reach your ideal reserve amount.
Only use this cash if you 100 per cent need it, and replace it as soon as possible, to make sure you always have your cash safety net. Don’t forget to make considerations for all of the things you’ll need to pay out for, including VAT and corporation tax bills which aren’t monthly costs.
Different funding sources for SMEs
If self-financing isn’t an option for you because you need to retain your small business’ profits each month, you can look to different funding sources. A line of credit or secured small business loan could help you build your cash reserve, for example.
This extra cash injection will mean your small business can start putting money in the bank as a cash reserve or to boost cash flow, without having to worry about taking money away from other areas of the business.
Alternative finance for SMEs
These two methods, however, are not always right for small businesses as they can often depend on the company having valuable assets and a sufficient cash flow in place to be eligible.
Alternative financing methods, such as an unsecured business loan, could be much more suited to your SME. They don’t require you to already have large sums of money in the bank and are much more accessible to UK small businesses.
Alternatively, a business cash flow loan could help your business start to build its cash reserve within around 24 hours of application. This short-term cash injection will help your small business put cash away in the bank, giving your business a secure safety net. These work especially well for seasonal businesses – particularly those that are coming up for a busy month and don’t have confidence in how much cash they have in the bank.
At Capify we offer a range of business loans to help support your business through high and low periods. Check to see if you’re eligible for one of our loans with our online eligibility checker. Or, if you’d prefer to talk to a member of our team, we’d be happy to guide you through the process. Give us a call today on 0800 151 0980.