Cash reserves are funds that companies set aside for use in emergency situations. The cash that is saved is used to cover costs or expenses that are unplanned or unexpected. In most cases, the reserves are specifically for short-term needs. One benefit of maintaining such a reserve is that the company can avoid credit card debt or the need to take on additional loan debt. (Loans are typically used for larger, planned financial needs.)
Businesses generally use their company bank account to store money saved as a cash reserve. The money may also be placed in a separate account, designated as the cash reserve account.
How Much Should Go into a Cash Reserve?
The amount that a company puts into a cash reserve account depends entirely on its needs. Financial experts generally say that a solid reserve is one that can take care of anywhere from three to six months of the company’s ordinary expenses.
Deciding on a reserve amount is an important financial decision for a company. Failure to set aside enough cash makes a company financially vulnerable – but holding too much in reserve means the company is not taking full advantage of the opportunity to invest more funds in growing its business.
It’s important for a business to review its financial statements to help determine how much should be placed in a cash reserve. Focusing on business expenses and earnings, as well as the company’s cash flow statement, is the standard way to determine how large a reserve should be. In most cases, it’s best to use the previous year’s cash flow statement to identify how much revenue the company earned and how much money it spent.
Subtracting expenses from total revenue reveals the total amount of money that went toward business expenses. That figure can then be divided by the number of months in the accounting period to determine the monthly cash burn rate.
For startups that don’t have financial statements yet, the cash reserve amount can be established by using the company’s projected cash flow and business budget. Subtracting the projected monthly expenses from projected monthly revenue gives the company a number that they can then multiply by the number of months the cash reserve should cover.
Cash reserves can also refer to short-term, highly liquid investments that individuals and companies make to gain quick access to financial resources without the need to have a large amount of cash around.
The Fidelity Cash Reserves are popular when it comes to investing in assets that are very liquid. It is a specific investment from Fidelity’s mutual fund family. The investment instrument is perfect for individuals, families, and businesses because it can give the order to liquidate and get the funds the same day.
Cash reserves are vital to companies. The reserve holds money that a business can use when unexpected costs come up or when revenues are down. Calculating company revenue and subtracting expenses gives companies the amount per month they need to cover themselves. Cash reserves should ideally be at least sufficient to cover six months’ worth of company expenses.
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