What size cash buffer should my agency have?

What size cash buffer should my agency have?

By Pamela Phillips.

Cash is King.

Everyone’s heard the saying ‘Cash is King’ right?

There’s a good reason for this. Did you know that 50% of small businesses fail within the first 5 years of trading? And 82% of those fail because of poor cash flow (according to Xero’s small business survey 2021).

If you’ve ever been in a position where you've had to make a choice between paying one supplier over another, holding off on paying your taxes, or whether you can afford to pay yourself that month, you’ll know how stressful cash flow management is can be.

Having a cash buffer doesn’t just serve you well when your business is going through tough times, it also gives you the ability to react to opportunities quickly as they arise. There may be an unexpected chance to hire a new member of staff, buy a property or invest in a new business stream. If you’ve got the cash at your fingertips it is easier to leap on those chances.

There are a number of healthy habits that you can build to improve the cash flowing into your business, including:

We’re not going to delve into everything on this list right now (get in touch if you’d like to chat more though!). Instead, we’re going to focus on how much cash you should keep set aside as a safety net for when your cash flow isn’t looking as rosy as you’d like.

How much cash should I set aside?

As a rule of thumb, having enough cash to cover 3 to 6 months of your spending is often held out as a good cash buffer. Certainly, holding a cash reserve of anything less than 3 months' worth of spending leaves your business vulnerable to unexpected events. 

This is a very broad brush guide and the actual guidance will depend on the nature of your business, your client base, and what stage your business is at - amongst other things.

There are a few factors you can consider and evaluate to create a more tailored cash buffer for your business. 

Here are 3 key elements we suggest you focus on right now…

Look at your past cashflow

 

From this you can see your net cash burn - this is the difference between your cash coming in from sales and your cash going out for costs (so, the total amount of money a company makes or loses each month). And also your gross burn - your costs going out (excluding any cash coming in).

It’s more prudent to set aside a multiple of your gross cash burn. Imagine if something happened that meant all your income just stopped overnight. As we all know, this can happen.

Look at your cash flow forecast

 

Your cash flow forecast will show you when you are likely to have peaks and troughs in your cash balance. Plus, it’ll show you when you might need to dip into your reserves to meet your payment obligations. Visit the Xero website and check out their handy cash flow forecast template for some extra guidance. 

Scenario planning can help you here too. We recommend you run your cash flow forecast assuming you lose your biggest client (or two).

Now, what does your cash flow forecast look like?

 

How easily can you access funding?

 

If you’re able to quickly and easily tap into funding when you need it - from banks, investors or even your own personal finances - then you can reduce the amount of cash buffer you hold in your business.

Once you’ve worked out what buffer you want to set aside, then you can readily create a plan to build up that buffer.

 

If you need some support with working out what cash buffer your agency needs, or how to set about building it, we’re here to talk. Let’s jump on a call to see how we can help.

 

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