The point of a business is to make money. To do that, first you have to spend money. After expenses, it’s all profit, right? No, you have to set some aside to reinvest into your business. It’s payday now? Nope, don’t forget your cash reserves..
Cash reserves are usually called the "rainy day" fund. But it’s doesn’t have to be raining outside… it doesn’t even have to be drizzling. The Belmont University blogs features Jeff Cornwall’s post on the effective and proper use of cash reserves.
There are four main times when you should use your cash reserves, and Cornwall describes them as four separate pools of cash with four distinct purposes. The first is money to be used for irregular expenses such as quarterly taxes, or large marketing campaigns. These are expenses that are off-budget, but crucial.
The second cash pool is to shore up your cash flow. In a perfect world, money would come in and go out in a smooth predictable path. As it is, there are good months and bad months, not to mention seasonal rushes. Use this part of your cash reserves to hit your minimums in the months your flow is low.
The third pool is the emergency fund. This monsoon-day fund is for when you lose a big customer, have a major accident, or some other calamity. The fund should be large enough to cover the day-to-day expenses for a month.
Finally, the last part of your cash reserves is the designated "war chest". This is what you use when you see a great, but time-sensitive real estate opportunity. Or if a competitor is on the ropes, you can swoop in to buy up inventory. Basically, if that once-in-a-blue-moon opportunity comes along, you’ll have the cash on hand to capitalize on it.
