What To Do with Excess Cash in a Business
Entrepreneurs have demands on their capital and reserve requirements that most others do not. Thinking about these in concert with personal needs and requirements requires a different approach. In this article, I analyze how to think about reserves, where to locate them and some of the trade-off decisions. Before jumping in, let us think about why each piece of capital is being held in reserve and segment capital reserve requirements into two categories and six pieces:
Business
- Business working capital needed within 90 days
- Business reserve capital that could be needed in 90-180 days
- Business reserves needed more than 180 days into the future
Personal
- Personal cash needed within 180 days
- Personal reserves that cover debt and expenses between 180-365 days
- Known big ticket items needed one-to-three years in the future
Short-term business reserves
Let us start with the business reserves. Working capital is the most straightforward and should be tailored to a business model. I typically recommend no less than 90 days of working capital availability as a target. This means that if you have a business disruption that reduces your revenue to zero for a full 90-day period, you can continue to meet all other business obligations. In most cases this will never happen, or if it does, you are making adjustments well before the 90-day mark.
The 90-day reserve decreases the strain of smaller revenue disruptions. For example, what if your revenue drops by 30%, but you think the drop will be temporary? With 90 days of reserves for 100% of expenses on hand, you can operate without changes for up to nine months. For another example, what if you have government contract revenue and there is a federal budget halt where payments are postponed to contractors for a few months? Reserves mean that you can continue to operate until payments come through.
Whatever the individual case, business operating capital means that you do not have to worry about making payroll or keeping the lights on, at least not right away. Operating capital should always be kept in cash and ready to use.
Mid-range business reserves
Next up are business reserves for 90 to 180 days into the future. Let us look slightly beyond cash toward things like money market funds or certificates of deposit. The rates of return for these types of holdings tend to follow prevailing interest rates and stay in the low to mid single digits.
You may be asking, “Why would I even bother to move money here?” For most of 2010 to 2021, I would have agreed with you and asked the same thing. How much effort would you want to take to generate another 0.25% to 1% on your cash? As of this writing, in mid-spring of 2024, those rates are now in the 5% range, and the difference between that and 0.1% on your checking account is worth the effort.
Long-term business reserves
Reserves beyond the six month range can really open up the menu for investment. For example, if you are looking to purchase a new commercial building in two years, maybe you start adding some municipal or corporate bonds. Maybe there are preferred certificate of deposit rates from your main bank if you meet certain minimums.
The further into the future, the more you want to think about the amount of volatility you are willing to accept for those funds. Adding things like public market equities can certainly increase the return possibility, but for anything you need in less than three years, it usually makes more sense to stay with cash, cash equivalents, bonds and certificates of deposit. If you end up earning 5-6% on your cash over the next two years, that is still another $10,000-$12,000 for each $100,000 you hold over that time.
Short-term personal reserves
On the personal side, the discussion on working capital is largely the same, but you may want to stretch the timeline out a bit more from 90 days to 180 days. Holding more in reserve personally increases the amount of business flexibility you have available, because reducing or eliminating owner distributions and salary for a period of time is usually a great lever to pull during times of short-term business disruption.
To come up with this number, you typically take all your recurring monthly debt expenses, like mortgage, tuition and car payments, and add your typical spending range on discretionary items. A great way to calculate this is to review the last six months of credit card and bank statements. Take the total outflow and subtract the debt expenses, and that is usually a pretty good estimate to work with.
So let’s say that you spent $240,000 in the last six months, and $48,000 of that was toward the mortgage and a car payment. Your monthly spending is likely $4,000 of debt service and $32,000 of discretionary spending. You could choose to reserve the full $240,000 or discount the discretionary spending a bit. I typically recommend reserving the full amount for extra cushion. Just like your working capital, this money should be sitting in cash accounts.
Mid-range personal reserves
Personal reserves between 180 days and one year are likely reserved for necessities or other known expenses during that time period. This area tends to be based more on how you feel about your unique situation. Some people like to reserve more, and some are just fine at the six month mark. There are no right or wrong answers here, but if you are keeping some additional capital on the sidelines for expenses between 180 days and one year, you should be looking at premium money markets or certificates of deposit.
Long-term personal reserves
Known big ticket expenses beyond one year open up the investment menu again. On the personal side, these are usually real estate purchases, tuition expenses, large family trips or investments in home renovations.
Work to match the timeline of when you will spend the money to when the investments are used. For instance, if you know you will be putting a 30% down payment on a $2M vacation home purchase in Oregon in two years, you are likely still looking to use lower risk investments like bonds as the majority of your allocation. The $400,000 you want to reserve would still generate an additional $40,000 of income over that period at a 5% rate of return, which is a nice bathroom renovation before moving in! Once you are beyond three years in the future you should be looking more heavily at things like equities to generate a higher rate of return.
The theme of cash and capital reserves for your business and family is to forecast what you will need and match the investments to that need. We do this work with our client families, so please reach out if we can help yours.
If you have a question or simply want to talk through your financial planning, we are here to help.
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DISCLOSURE: Jarrod Musick is an officer of Destiny Capital and Entrepreneur Aligned, a DBA of Destiny Capital. This article is for informational purposes only and should not be relied upon as a basis for your investment, business, or personal financial decisions. We recommend consulting with your wealth advisor, CPA/tax advisor and/or attorney, as applicable to your situation, prior to implementing any new tax, legal, or investment strategy. Advisory services provided by Destiny Capital Corporation, a Registered Investment Adviser.
ABOUT JARROD
Jarrod was born into financial planning and solving financial problems. With his financial advisor father Steve telling stories about finance around the dinner table from an early age, the idea that everyone has a different financial situation was always there. After an early professional career spent in nonprofit and government, Jarrod came back to his roots helping people plan and invest in 2011. Since then, he has worked with individual clients, led internal teams and ultimately became partner and the CEO of Destiny Capital in 2017. With a passion for helping entrepreneurs change the world, Jarrod ultimately oversaw the creation of Entrepreneur Aligned in 2020. With both Destiny Capital and Entrepreneur Aligned, Jarrod leads teams that help people live lives of abundance where money is simply a tool to let everyone be a positive force for the world around them. When he isn’t working with the talented teams for EA and DC you can find him chasing his twins, wily trout or a podium spot at an OCR race.