Most businesses should keep 2 to 3 months of operating expenses in cash reserves. But that’s the average. The right number for your business depends on how predictable your revenue is, how concentrated your client base is, and how much risk you’re carrying.
Most new clients land at one extreme or the other. They show up with either no reserve at all, or a massive cash reserve. One of my first recommendations for new clients is either to build one up (if they don’t have one), or to strategically invest some of it (if it’s way too large).
Why Cash Reserves Matter
Cash is the lifeblood of a business. Without it, you can’t pay employees, can’t pay vendors, and operations stop. Profit alone doesn’t keep the business going—cash in the bank does.
Every business transaction adds up. The way you spend and earn each incremental dollar is the way you spend and earn all of your dollars. Good decisions in the short term compound into long-term success. Cash reserves exist to protect that compounding when something goes wrong.
I’ve seen owners forced to put their own money into the business because reserves weren’t high enough to cover a slow period. That works if the owner has the personal funds to cover it. I’ve also seen owners who didn’t have that cushion. They had no choice but to lean on a large line of credit, and it cost them tens of thousands of dollars in interest. And without a line of credit to fall back on, that same shortfall can be enough to put a business under.
How to Calculate Your Cash Reserve Target
Start with your average monthly operating expenses, and multiply that number by 2 to 3.
Example: if your business spends $100,000 a month to operate, target $200,000 to $300,000 in reserves.
That’s your baseline. From there, adjust up or down based on your specific risk profile.
When to Keep More Than 3 Months
Some businesses carry more risk than others. If any of the following apply to you, lean toward the higher end of the range or beyond.
- Client concentration. If one client makes up 20% or more of your revenue
- Your revenue is seasonal. Food and beverage businesses, retailers, and companies tied to weather or holidays need enough reserve to cover the slow months without borrowing.
- You’re in a high-risk industry or economic environment. During downturns or periods of tight credit, cash on hand becomes more valuable and harder to raise.
- You don’t have access to a line of credit. If a bank credit line is available as backup, you can run a little leaner on reserves. If you don’t have that, your cash reserve is your only safety net.
When Less Can Work
If your revenue is diversified across many clients, your business is stable and mature, and you have strong access to credit, running closer to 2 months can be reasonable. The goal isn’t to hoard cash for its own sake. It’s to match your reserve to your actual risk.
The Cost of Holding Too Much Cash
Some owners hold onto as much cash as possible. Here’s the thing: Cash sitting in a bank account isn’t working for you. Cash is eroded by inflation every day. Every dollar above what you need for safety is a dollar not funding growth, not paying down higher-interest debt, and not invested somewhere with a return.
I’ve seen businesses hold 12+ months of reserves out of habit or fear. Those same businesses are almost always struggling with revenue stagnation. Holding too much cash is a missed opportunity. Once you’ve hit your target range, put the excess to work: pay down debt, fund the next hire, or invest in equipment, locations, or products.
How to Build Reserves If You’re Starting From Zero
If clients don’t have a reserve yet, I don’t tell them to try to fund it in one month. Set a target percentage of monthly profit, often 10% to 20%, and route it to a separate account automatically before you see it in your operating cash.
How We Help Clients With This
We build cash flow reports for clients so they can see money coming in and going out before it becomes a problem. We also build budgets and forecasts so reserve targets are based on where the business is headed. From there, we help clients decide where excess cash should go: reserves, debt paydown, or reinvestment.
Schedule a conversation with Sentinel Finance Group.
Eric Reinacher is a fractional CFO who brings over a decade of financial leadership experience working with growing companies. He helps business owners improve financial visibility, make better decisions with their numbers, and build businesses that increase in value. LinkedIn
Sentinel Finance Group is a Kansas City-based fractional CFO and controller firm serving growing businesses across the US.
Frequently Asked Questions
How much cash reserve should a small business have?
Most small businesses should target 2 to 3 months of operating expenses in reserve. Businesses with concentrated clients, seasonal revenue, or no credit line access should target higher.
Is it bad to have too much cash reserve?
Yes, past a certain point. Cash above your reserve target isn’t earning a return and could be used to pay down debt or reinvest in growth.
How do I calculate my cash reserve target?
Take your average monthly operating expenses and multiply by 2 to 3.
What counts as operating expenses for this calculation?
Payroll, rent, insurance, recurring vendor and subscription payments, marketing, etc. Leave out one-time or irregular expenses and debt service.
How fast should I build my cash reserve?
Route 10% to 20% of monthly profit into a separate reserve account automatically, rather than trying to fund it in a single month.
