Many executives and analysts will argue that there is no perfect balance or ratio for cash on hand in your business. In our opinion, every industry differs and the reasons for having cash on hand could vary greatly depending on those industries.
I've recently been asked to give monthly cash on hand estimates to executives which seemed like an odd question since it can vary greatly. Then it prompted me to look into the models and how we are deriving cash on hand for the businesses we consult.
This led me to question how much cash on hand I advise businesses to keep in the business.
One important aspect I began to look more closely at was how fast the company collects its receivables, seasonal inventory requirements and available credit lines. If no line of credit was available to the business the cash on hand increased significantly. If you collect on your receivables quickly, say within 30 days; then you need less reserve cash than if you collect your receivables within 120 days. In addition, for companies that had more than 3 year's worth of data, I studied a frequency pattern of the cash coming in. This determined slow months when more cash on hand was needed to cover expenses for raw materials, salaries and benefits, etc... The month's with more robust sales could generally reduce cash on hand. A variable percentage was calculated based on expense to projected sales ratio.
(Please note, rational sales forecasts are needed for this, and over-inflated projections can ruin the cash on hand needs)
In addition to what the business is currently doing I look at the current forecast and next fiscal year budgets to get an idea of where the expenses are heading. For industries that are capital intensive or companies that have large projects scheduled for future months, we would need to reevaluate their cash on hand projections in accordance to their spending. Many companies have the same recurring expenses month-in and month-out. However, one large project can offset this amount and require additional cash on hand each month until the project is complete.
Nonetheless, your business needs to keep cash on hand, whether it be as little as thirty days or as great as twelve months to stay afloat. The last crisis you want to worry about as an executive is not being able to keep the lights on while sales are robust.
If you have any questions feel free to write me directly at firstname.lastname@example.org.
Doug C. is a Financial Analyst for a top 20 Fortune 500 Financial Services company and owner of YIPFolio Financial & Management Consulting Services. He specializes in Financial & Accounting services including balance sheet, P&L, fixed assets, and capital funding. He has spent several years in the Hosting and Technology industry while consulting management and senior management on all aspects from raising capital to managing daily cash flow. Doug received his BS in Finance from Fairfield University and resides in the Greater New York City area.