Certain misconceptions surround cash reserves. The most common one is that such funds are meant to serve negative financial conditions only. This is not true. Expert entrepreneurs know enough to maintain cash reserves for the moments when big opportunities arise.

For instance, a new government policy might serve to advance business growth and an entrepreneur can immediately access their reserve funds to position as the first business servicing the new opportunity. 

We will go on to introduce you to cash reserves, the benefits of these assets, and how to go about building them. 

What is a Cash Reserve?

Cash reserves refer to funds that businesses or individuals set aside for use in emergencies, for unexpected expenditures, or at times when there is low or inconsistent revenue. In other words, cash reserves could be described as the minimum amount of money that businesses must have at hand or readily accessible to meet basic operational requirements. 

These funds help to create financial resilience and foster business continuity. How does that work? Simple. Reserve funds serve as a means for a business to maintain critical activities and continue normal operations in times of difficulty. 

A huge but tricky difference separates business cash flow from profit. This article by Extra Co Banks explains it quite clearly. Similarly, cash reserves are different from profit; in the sense that profit indicates the balance after expenses are deducted from revenue but cash reserves are an application of such balance.   

The Benefit of Having Cash Reserves

Holding and maintaining cash reserves are the secret to business stability and also a sure way for businesses to attain high valuations. In this section, we drill down on some of the many benefits of maintaining a decent level of cash reserve in your business. 

Investor Confidence:

Holding cash reserves means that a business has the means of managing contingencies. The more the value of such reserves, the higher the capacity of the business to find balance in turbulent economic times. This direct relationship impacts the way the public views and values the brand. 

Customers understand that their services will not be interrupted by a fold-up when they are dealing with this kind of business and investors know that customers will keep patronizing the business. The idea of continuous customer patronage suggests that business is set to prosper. This builds investor confidence and increases their willingness to invest in such a company. 

Business Continuity:

The basic reason for holding cash reserves is to have a financial cushion; something to fall back on in the event of an economic hardship, business unproductivity, and the like. Readily available funds make it possible to continue operations and stay afloat enough to restart or replace failing revenue engines. 

Take the COVID-19 pandemic for example. At the peak of the outbreak, businesses were forced to operate fewer hours or shut down completely, in addition to following stringent operational guidelines. Service delivery took a hit and countless entrepreneurs reported having losses, realizing plummeting revenue, and experiencing financial constraints. 

The only businesses that scaled through were those capable of making the short, impromptu switch to remote operation. Lots of funds are required for this transition and, since banks were uncertain about the future of many businesses, it was nearly impossible to access a loan or credit service. Businesses had to turn to their cash reserves - which is exactly what those reserves are for, by the way. 

Access to Financial Resources:

Lending institutions typically consider the economic resilience of businesses before giving them access to financial resources such as loans. As we’ve mentioned earlier, the amount of cash reserve a business has directly determines its economic resilience rating. This, therefore, implies that having lots of cash reserves could increase a business’ chance of accessing financial resources when they need them most, and having less could mar those chances.  

Flexibility in Decision-making:

Let’s put it this way. Imagine that a business has an urgent problem to address and it also has three possible options. Option A would fix the problem but only temporarily, Option B would fix the problem but requires more money than the first, and Option C would fix the problem and other associated issues but requires much more money than the other two options. 

Now, let’s say that the current business revenue narrows down its capacity to the first option, but the top management wants the problem sorted out in the best possible manner.

This goes without saying that a huge cash reserve will come in handy. Moreover, the reserve size could offer the business access to all three options by simply providing the funds to finance anyone it chooses. The availability of large-scale monetary reserves in big-size business situations eases the problem-fixing process and gives institutions the flexibility to choose whichever options work best for them. 

Debt Avoidance:

It is clear-cut and very straightforward how having cash reserves saves businesses - and even everyday people - from debts. Simply, you need money and rather than approaching a lending institution, you turn to your reserves for help. Nothing else spells debt avoidance better than this. 

Despite expert financial strategies, a business always tends to fall into loan debts. This doesn’t have to mean the end of the world. All it takes is maintaining the right track in generating revenue, managing funds, and growing reserves, and any business will make it out alive. 

Businesses that succeed at these three things are better positioned to pay off loan debts (especially at a consistent rate) without bailing on their critical functions or responsibilities. Specifically speaking, the availability of cash reserves makes debt management seamless as it balances off financing the day-to-day activities of the business with diligent debt servicing. 

How Businesses Build Cash Reserves

This section will serve to inform business owners of the many ways they can approach building cash reserves. 

Determining the Size and Optimal Level of Cash Reserves

There’s no need to save so much that you are perpetually short on funds for running your business. New entrepreneurs who are also very enthusiastic about making the right financial moves might find themselves in this situation. Ultimately, they have to go back and forth accessing their cash reserves and this could accumulate into significant operational changes over time. 

A better way to go about creating cash reserves is to determine the amount of funds you need - for a predetermined period of operation. Doing the maths will reveal how much of your income will be left within the specified period. This balance will then serve as a pointer for what the size and optimal level of your cash reserves should be.  

Balancing cash reserves and business investments

Cash reserves and business investments are two opposite ends of the same coin. Reserves provide a source of immediate, easy-to-access funds. They are not intended to yield any increase and most often, their value decreases in the face of biting economic situations.

Alternatively, investments bring in returns but they are not easily accessible and may even lead to complete loss of funds. 

These two mechanisms are important to any entrepreneur who wants real financial success. Typically, cash reserves are necessary for maintaining financing operations and making impromptu purchases whereas investments help to cushion against the impact of inflation on reserved funds by providing returns. 

Applying both short-term and long-term vehicles correctly could mean the difference between collapsing under the weight of economic inflation or losing the capacity to respond to contingencies, and maintaining exciting revenue and profit levels.

At any point in time, businesses can determine whether to favor cash reserves over investments or vice versa, by analyzing the current economic conditions and estimating how this might change over the foreseeable future. 

Right approach to cash management 

High Radius suggests that every cash manager must follow steps that involve “forecasting future cash flows, ensuring there’s enough liquidity to cover short-term obligations, optimizing working capital to minimize excess tied-up cash, and managing risks that could impact cash reserves.” 

We agree that all of these six steps condense into a comprehensive approach to cash management, which precedes the right decisions for creating and maintaining cash reserves. 

Conclusion

Exploring the subject of cash reserves has opened us to concepts such as cash flow, profits, and investments. These are all topics you must wrap your head around if you want to successfully build reserves for your business.

In addition, you must ensure that you are not misled by the numerous misconceptions surrounding cash flow and by extension, cash reserves. We recommend you browse through our blog here to access more articles that will answer your questions and feed your knowledge toward growing a successful business. 

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