In the world of small businesses, uncertainty is one of the few certainties. Whether it's unexpected equipment failures, sudden changes in the market, or unforeseen expenses, the unpredictable nature of business can catch even the most diligent entrepreneur off guard. One tool that can help small businesses weather these storms is a cash buffer. But what is it, and why is it so crucial?
What is a cash buffer?
A cash buffer is essentially a reserve of funds set aside to cover unexpected costs. Think of it as an emergency fund for your business, a financial cushion that can help you navigate unexpected rough patches without compromising your day-to-day operations.
By the numbers: the hard stats
- According to a JP Morgan Chase study, small businesses hold an average of 27 cash buffer days in reserve. This means that, on average, they could cover 27 days of outflows without any new cash inflows.
- The same study also revealed that certain industries, like retail, have smaller cash buffers, averaging around 19 days, while real estate holds about 47 days.
- A U.S. Bank study by Jessie Hagen found that 82% of small businesses fail because of cash flow problems. While not all of these issues are directly related to the lack of a cash buffer, having one certainly provides a layer of protection.
Why is a cash buffer important for small businesses?
There are various reasons why maintaining a cash buffer is not just advisable but essential for the survival of small companies:
- Unpredictable revenue streams: Small businesses often rely on few income sources. This makes them more vulnerable to market fluctuations. A cash buffer can help bridge the revenue gaps during lean months.
- Limited access to credit: Big corporations typically have easier access to credit lines and loans at favorable terms. In contrast, a smaller business might face challenges securing funds, making a cash buffer an essential backup.
- Unexpected expenses: Whether it's urgent equipment repairs, unexpected tax bills, or sudden operational costs, unexpected expenses are inevitable. A cash buffer ensures these don't disrupt your business operations.
- Flexibility in decision making: With a safety net of funds, businesses can make decisions based on long-term strategy rather than immediate cash flow concerns. This might include investing in growth opportunities or innovative ventures.
- Crisis management: Be it a global pandemic or a local economic downturn, unexpected crises can hit hard. A cash buffer can mean the difference between shutting down and surviving through challenging times.
How to build your cash buffer?
Here are the practical steps for building a healthy cash buffer for your small company:
- Analyze and project: Start by understanding your business's monthly operational costs. Knowing your expenses can help you set a realistic target for your buffer.
- Start small: Even if it's just a small percentage of your monthly revenue, regularly setting aside a portion can gradually build a substantial buffer.
- Cut non-essential costs: Review your expenses and identify areas where you can cut back without affecting the core of your business. These savings can be directed to your cash buffer.
- Consider a separate account: To avoid the temptation of tapping into your buffer for everyday expenses, consider keeping it in a separate bank account.
- Regularly review: Business expenses and revenues can change, so make it a habit to review and adjust your buffer goals annually.
Key takeaway
A cash buffer isn't just a luxury or an item on a best-practices list; it's a lifeline. For small businesses operating in an unpredictable landscape, building and maintaining this financial safety net could be the decision that ensures longevity and success in the face of adversity. So, while the skies might be clear now, remember: it's always best to carry an umbrella before it starts to rain.