By David Prosser
How much cash at hand does your business really need? While there is no single right answer to that question, because every business is different, it’s an important financial planning issue to review regularly. And during periods of elevated volatility and risk – like right now – your business may need to increase its cash at hand to create a comfortable safety buffer. Still, that doesn’t mean you have to give up opportunities to earn a commercial return on this money.
The nature of uncertainty makes it difficult to plan for in a targeted way. You can’t predict whether President Trump will unveil a new tariffs regime that makes it more expensive to sell your products in the US. Or whether a further outbreak of hostilities in the Middle East will send your energy costs spiralling. Let alone whether a cyber attacker might leave your business paralysed.
However, you can build flexibility into your financial planning, so you’re prepared for such threats. When volatility is on the increase, giving yourself a bit more headroom will give the business a better chance of weathering the storm, wherever the lightning happens to strike. Just as you drive more slowly and leave longer distances behind the vehicle in front when the roads are icy, so you can protect the business during adverse trading conditions.
Three to six months of cash at hand
The standard opinion from finance professionals is that businesses should aim to have cash on hand to the value of at least three to six months’ worth of their operating expenses. In other words, your cash reserve should be enough to keep the business afloat if not a single penny of revenue were to come in over the next three to six months.
That’s not to suggest such a severe crisis is likely amid the current volatility, though the pandemic proved that even the worst-case scenarios can come to pass. But this is the sort of buffer that will protect you if cashflow takes a significant turn for the worse, either because your costs spike upwards or revenues take a hit.
Based on that broad principle, now might be a sensible time to adjust your business’s cash on hand. If you’re not even close to three months today, prioritising your reserves would be sensible given the external environment. If you’re at the lower end of the range, now may be the time to move closer to six months’ worth of expenses.
Make the decision that’s right for your business. Generalised advice is fine, but most business leaders will have a more precise feel for what’s appropriate in their organisation, based on the level of risk it potentially faces as well as how and where it trades, and who with. Just be honest with yourself – when times are tough, it’s easy to overlook cash at hand, or even to regard it as a piggy bank to be raided for other priorities. In the end, your number one priority must be ensuring the business can stay afloat if a major problem does materialise.
Put your safety buffer to work
The good news is that cash on hand can still generate returns for your business. It may not be available for productive investment, but even in the current low-interest rate environment, you can earn substantive rates of interest on cash in the bank – as long as you make the effort to identify the best deals.
United Trust Bank, for example, currently pays annual interest of 3.9% Gross/AER* variable on its Business Easy Access Tracker** account, including an introductory bonus rate of 0.9% for the first 12 months after you open the account. With inflation currently standing at 2.8% in the UK, that’s enough to earn a positive real rate of return, even on an account where you have immediate access to your money.
Equally, you can take a portfolio approach to cash at hand. If your reserves are worth the equivalent of, say, six months’ worth of operating costs, it’s difficult to imagine a crisis when you’d need to access the whole lot upfront. In which case, consider splitting up your cash at hand – particularly if you’re building up your reserves – into several different pots. And if you can earn higher rates of interest by agreeing to tie up some of these pots for a bit longer, take advantage of the opportunity as long as you have at least some cash available immediately.
It’s worth playing around with your portfolio to secure the best possible deal. United Trust Bank currently pays 4.15% Gross/AER variable on is Limited Access Account, for example, which allows you to make two withdrawals in a calendar year without losing this top rate. Its Business 60-day Notice account pays 4% Gross/AER variable, which could work well for a pot of cash at hand you’re confident of being able to wait 60 days to access. UTB’s Business 1 Year Bond pays 4.55% Gross/AER * fixed, but you have to wait 12 months to get that interest, so the account suits money you can tie up for a more extended period.
Inflation protection is important too
In practice, this is something of a balancing act. Your first task is to think seriously about how much cash your business needs available to protect against mishaps and uncertainty – and whether that figure needs to rise in this more volatile time. Then you can think about how to divide up that headline figure so that you’ll earn the highest rates of interest on the money but have access to the right amounts of cash when you need it.
Take a prudent approach. By being conservative about your likely needs – both on when and how much you’ll need cash at hand – you’ll keep the business safe. But don’t think of this cash as money sacrificed for security; you should aim to maximise your earnings on every penny of it, even if it’s spread across several different pots.
Indeed, with inflation one of the uncertainties that worries many businesses right now, targeting the best possible real rate of return is more important than ever.
*AER stands for Annual Equivalent Rate and illustrates what the interest rate would be if interest was paid and compounded once each year. Gross is the interest rate without the deduction of income tax. Interest is paid gross into your account.
** The interest rate is variable and tracks at the Bank of England Base Rate (BoE) for the duration of the account.
Although this article may contain helpful information and tips, this is not advice. You may wish to seek advice from a financial advisor if you are unsure about next steps. The standard FSCS protection limit is £120,000 per eligible person, per institution. For joint accounts, this protection extends to £240,000 in total (£120,000 per named account holder).