Healthy Cash Flow. Great, Now What Should You Do With It?

Healthy Cash Flow. Great, Now What Should You Do With It?


Are congratulations in order? Or perhaps you’re just thinking positively – I like it!

If you’re in the enviable position of having an excess of cash on hand, you have the power to take advantage of opportunities to invest in your business. But before we get to that fun topic, let me answer your first question.

Conventional wisdom holds that a business should have liquid assets (cash in bank accounts and very liquid investments) equal to three to six months of operating expenses. That’s a nice rule of thumb, but I like to separate cash into a monthly operating account and a contingency fund.

Put simply, the operating account should carry a sufficient balance to cover the lowest cash-inflow month of the year for your business. (Seasonal businesses should have enough cushion to last through both their busy and slow seasons.) It’s your contingency fund that should equal three to six months of operating cash.

Here’s how to calculate both:

  • Analyse the last 12 months of costs, broken down into production costs (otherwise known as cost of goods sold in manufacturing or distribution businesses or cost of sales in service businesses), and overhead costs that are spent every month, regardless of sales volume.
  • Take your current assets (bank balances, outstanding accounts receivable, inventory value) and subtract your annual liabilities (taxes, accounts payable, loans payable in the short term), divide by 365 to get to your daily operating capital. Multiply this by the number of days to arrive at a contingency amount you‘re comfortable with.

Still not sure what’s comfortable for you?

Run cash-flow forecast scenarios covering various possibilities: Average expected operations, a worst-case scenario, a best-case/high-growth scenario.

For your worst-case scenario, consider what would happen if you lost your best customer or top sales person, if there were a fire or natural disaster, etc. (When I was with a coal-mining machinery and services company, we lost $1 million in cash in six weeks when the coal miners’ union went on strike, and all of our customers stopped buying. To survive we had to take draconian measures with our own suppliers.)

Figure out a contingency number that won’t starve your current operation but will keep the business alive in case something goes south. Park this amount in a separate bank account or a short-term investment such as a money-market fund, and use it to secure a line of credit with your bank.

Now, for your second question. If you have more than enough dough on hand to cover both current operations and your contingency fund, use the extra cash to grow your business. Upgrade your equipment to boost capacity or efficiency, bring on additional sales staff or consider an acquisition.

Whatever you do, don‘t sit on your money. To reach this point, you’ve been doing something right, and you should take advantage of your business’s success.

Bonus baby

Contingency fund? Check. Expanded operations? Check. Still have money left over? This is when you start budgeting for the next three to five years.

Think about where you want to be by that time and what it’ll take to get there. And if you still believe you have cash to spare, only then should you pull it out of the business for yourself.

Just make sure to consult with your accountant and financial planner to determine the best way to distribute and invest the funds.

Joe Worth
Joe Worth, Vice president of operations and partner at B2B CFO, has been a CFO for several public and privately held companies.