Looking for a straight answer on how big a cash reserve should be? Steven Palmieri, a Tax CFO, has one that may not be what you hoped for. No published number of weeks fits every business, and we do not pretend one does. The right cushion is the one your own bad month calls for, and it can be worked out from your books in an afternoon.
Start with the worst month you have had in the last two years. Pick the worst one that actually happened, and leave out the worst one you can imagine. Write down what came in and what had to go out. Payroll and rent do not shrink when sales do, so they set the floor. Add the insurance deductible if your area gets storms, and add anything that comes due once a year, such as a franchise report payment or property tax.
That total is the first honest size for the reserve. It ties to something you have already lived through, which makes a better starting point than a rule borrowed from a magazine.
A reserve that sits in the operating account does not last. It looks like spending money, so it gets spent. Open a separate business savings account, give it a name that says what it is, and move money in on a schedule. Keeping business money apart from personal money is basic record keeping, and the same habit applies here. A reserve account does not have to earn much. It has to be hard to dip into by accident.
The reserve is cash you already own. A credit line is borrowing you can use if the reserve is not enough. If you rely on the line alone, the bank decides when you can reach the money, and banks are often least willing when you need it most. If you rely on the reserve alone, one large surprise can drain it. Most owners with a swinging year want both, with the reserve first and the line behind it. Set up the line in the calm months, while your statements look good. The page on when oil prices move your revenue shows how the two work through a soft stretch.
The most useful part of a reserve is the rule you write down before you need it. Say what counts as a reason to draw on it. A sales drop of a certain size, or a closed week after a storm, or a customer paying more than sixty days late. Say how it gets refilled, perhaps a fixed share of every month that closes above its average. When these rules exist, the reserve does its job. When they do not, it gets argued over at the worst possible time.
In the quiet months, the one decision this page asks of you is the first transfer. Choose the amount, open the account and move the money. A small start beats a perfect plan that never begins.
Owner draws and estimated tax payments change what is left to hold back. If a strong month is taken out as a large draw, the reserve is empty before the soft month arrives. If the estimates are set from the months that have closed, the tax payment follows the real year and not last year's. We decide draws, estimates and the reserve together, so each choice has the others in view. The return comes from those same books, so there is one version of the story.
Say a small company's worst recent month needed $30,000 for payroll, rent and bills, and its sales that month brought in $18,000. The gap was $12,000. A deductible of $5,000 sits on top for storm season. A first reserve target of $17,000 would have covered that month completely. The owner funds it at $2,000 a month and reaches the target in about nine months. These figures are only an illustration and do not describe any real company.
On a free Second Look call, we look at your worst month together, size a first reserve, and decide where it lives. There is nothing to sign and nothing to pay. For storm season in particular, see hurricane season and your cash, and for the full picture of the year ahead, cash planning for a year that swings.
You will be talking to the Steven Palmieri practice.