How Much Should a Business Save?

No one knows if the U.S. economy will enter a recession in six months, a year, or not at all. Businesses do know, however, that they want to be prepared with cash reserves for any change in cash flow, no matter its cause.

The hard part for owners and managers is figuring out what kind of cash reserves their business needs. And then they need a plan to accumulate those reserves.

It’s definitely the right time for businesses to focus on their cash reserves. Small business revenues and employment growth held mostly steady year-over-year in 2023. But, more than 9 in 10 reported either a financial or operational challenge during the year, according to Fed Small Business, which aggregates small business research published by the Reserve Banks of the Federal Reserve System. A February 2024 survey by the National Federation of Independent Business also found that owners expect financial headwinds in the months ahead.

So, how much should a business save for whatever challenges may come?

To begin with, identify the expenses required to keep the business running this month. For example, if you have $50,000 in sales and $30,000 in expenses, the business runs at a net burn rate of $20,000 per month. This tells you two things:

First, how much you need saved in your cash reserves will be a function of $30,000 (your monthly expenses) times the number of months you want to be able to run with $0 in sales. The U.S. Chamber of Commerce recommends businesses keep at least three to six months’ worth of cash on hand. “Cash ‘on hand’ refers to any accessible money, funds in bank accounts, or liquid assets that could be accessed within less than 90 days,” it says.

Second, knowing your net burn rate tells you how far sales would need to decline before the business needs its cash reserves in a month. Using the example above, sales would need to be down more than $20,000 before you touched the reserve.

Managing net burn rate and expense, however, is rarely straightforward. The U.S. Chamber says determining how much money your business needs on hand depends on its stage. Is it a startup company or an established enterprise? Owners and managers must then consider historical spending, cash accessibility, industry, and other factors.

Often, creating a plan to save reserves is a bigger challenge than knowing what amount is necessary. Many businesses struggle with uneven cash flow. In fact, according to a recent study by Quickbooks of 2,800 businesses, almost half have cash flow problems. Three in five have unpaid invoices amounting to $30,000, on average.

Owners and managers can address the root of cash flow struggles and create more room in their monthly budgets to save reserve by strengthening weaknesses in their accounts receivables process. Translation: Focus on improving your ability to get paid.

In a perfect world, a business would provide customers with the ability to pay invoices immediately. The reality is that many businesses are stuck in an excel-spreadsheet-driven, 30-day-by-snail-mail process. Consider upgrading your accounts receivables process by:

1. Automating invoicing and accounting
2. Offering electronic payment options, even if you need to increase prices to pay processing fees.
3. More clearly communicating your payment terms
4. Adding late fee language to invoices
5. Automating messaging for payment reminders

If your business is like the average and has $30,000 in unpaid invoices outstanding, collecting just a third of that could provide room for saving reserves. An improved ability to get paid will help ensure your business keeps money coming from paying customers, no matter what challenges come down the road.