Hurricane Harvey has caused a tremendous amount of damage in Houston, TX. Unfortunately, many of these businesses are relying on their insurance to cover the damages. However, many business owners may be disappointed that their policies have exclusions that leave them holding the bill for much of the rebuild and repair. Sadly, many of these businesses will never recover.
There is one insurance policy that has no exclusions: CASH.
Cash reserves are available, uncommitted cash in the bank, separate from your everyday operating cash. We often recommend to our clients that this money is put in a separate bank account, left untouched, and slightly inaccessible to avoid the temptation to use it to fund daily operations.
Why is it important to have adequate reserves? Whether it’s weathering rough economic times, or covering payroll when a critical customer pays late, or unexpected expenditures such as natural disasters like Harvey.
So what’s the magic number? How much should you have in your account? Of course, the answer is it depends. We recommend at least 30 days of cash on hand to fund your operating expenses and keep the “lights on.”
You may need to adjust this reserve amount based on a number of factors:
- Speed of customer payments
- Length of your sales cycle
- Vendor terms
- Availability of line of credit
If it takes you a long time to collect from your customers or turn over your inventory, you may find you need more. If you have vendors that have negotiated favorable, longer terms you may need less. It pays to have your CPA or a firm like ours help you calculate what the adequate reserve should be.
Don’t be discouraged if you don’t have 30 days of cash on hand. Most of our clients rarely do at the beginning. However by employing certain strategies, you can start squirreling away funds to that account and eventually, and gradually build your reserve.
Establishing a cash reserve isn’t a fix-it-and forget it exercise. Cash reserves need to be monitored and adjusted as your business changes.
We can all take a lesson from the disaster in Houston. Create your own exclusion-free insurance policy; build a cash reserve.