How much cash should a business keep in reserve?
A common rule of thumb is to keep about three months of operating costs in cash. It's a good starting point, but the right number depends on how steady your income is, how fast you're growing and what you'd do if sales stopped for a month.
The cushion isn't idle money. It's what lets you pay yourself steadily, sleep through a slow season and say yes to an opportunity without borrowing.
Start with three months of costs
Add up a normal month's operating costs: payroll, rent, software, insurance, supplies and loan payments. Leave out costs that rise and fall directly with sales, such as materials for a job. Three times that is a reasonable starting cushion.
When to keep more, or less
| Keep more when | Keep less when |
|---|---|
| Income is seasonal or comes in large, uneven payments | Income is steady and recurring, such as subscriptions or retainers |
| A few customers make up most of your sales | Sales are spread across many customers |
| You're growing fast and spending ahead of revenue | The business is mature and costs are predictable |
| You have large annual bills or loan balloons coming | You have an unused line of credit as a backup |
Where to keep it
Keep the cushion separate from the account you pay bills from, so it doesn't get spent by accident. A business savings account or a Treasury money market fund at your bank or brokerage earns interest while staying available within a day or two.
A line of credit is a useful backup, but it isn't a cushion. Banks can reduce or close a line exactly when business slows down.
Set taxes aside separately
Money set aside for this year's taxes isn't part of the cushion. If you own a pass-through business, move a share of each month's profit into a separate tax account so the cushion stays whole when estimated payments come due.
How the cushion fits with paying yourself
Once the cushion is full and taxes are set aside, the cash above it is what you can take out or put to work. When a slow month dips into the cushion, refill it before taking extra.
Common questions
Is three months of cash enough?
For a steady business with many customers, often yes. Seasonal businesses, fast-growing ones, and those that depend on a few large customers may want six months or more.
Should the cushion include payroll?
Yes. Payroll is usually the cost you most need to cover in a slow month, so it belongs in the monthly costs you multiply.
Should I pay off debt or build the cushion first?
Build at least a small cushion first, then pay down high-interest debt. Without any cushion, one slow month puts the debt right back.
Does the cushion earn anything?
It should. A business savings account or Treasury money market fund pays interest and keeps the money available.
Related
Cratchit keeps the books for every company, shows what's safe to take out, forecasts the next 13 weeks of cash, and tells you what needs your attention. Take a guided tour with the Harpers, a sample family.
Try the demoEducation, not advice. Confirm the details for your business with your CPA.