How to Build a Cash Reserve

By Marco Terry
March 29, 2016

Although we are in early 2016, the Great Recession of 2007-2009 is still fresh in the memories of many companies in the construction industry. Put bluntly, it nearly decimated the industry in many regions.

Unfortunately, there is no way to guarantee that any company will survive a recession. There are too many factors at play. But I believe that some of those companies that failed during the recession could have survived if they had a well-planned cash reserve in place. Actually, companies with a solid reserve would have been well-positioned to gain from the market momentum that followed the recession.

Let’s explore the details of how to build a cash reserve.

Operate a lean business

The first step in preparing yourself for a recession is to operate a lean business. A lean business wastes little money. Although most business owners like to think they run lean businesses, the reality is that most don’t.

Review all your expenses—one by one—and determine if they are really needed. If they are not necessary, consider cutting that cost. If they are needed, evaluate if you can outsource that function at a cheaper cost.

For example, many glass companies manage their own payroll. That is fine, but managing payroll can be complicated and time-consuming. And there are penalties if you get it wrong. Payroll is easy to outsource. Many providers offer inexpensive and reliable payroll services.

The next step is to assess the products and services that you offer. Are any products contributing little to the bottom line? Or, worse, are they creating a loss and costing you?

Don’t wait until a recession hits to review which products to cut. It will be too late. The right time to cut costs is when things are going well and you have room to maneuver.

Determine cash reserve size

After you cut costs, you need to plan your reserve. A cash reserve is an essential tool for surviving business downturns. Your glass company must have a reserve. Without one, in an emergency, expenses will pile up before revenue comes in. This scenario will drive you to bankruptcy.

Your first step is to determine your monthly expenses. With this information, you can now determine the size of the cash cushion. There is no exact science for this process. Some businesses keep three months of expenses, while others set aside as much as six months’ worth of expenses. I favor higher reserves.

During this process, get advice from your finance department and from your CPA. Consider this guidance a business-saving investment.

Start building the reserve

Building the cash reserve is the simple part, though it is not easy. It requires dedication and discipline. Open a new bank account in which you will keep the reserve funds, and start making deposits.

Send a portion of your profits to the reserve account regularly until you reach the desired amount. Once you reach the limit, don’t touch the money unless there is an emergency.

Balance growth and safety

Money held in reserve cannot be used to grow the business during normal times. Unless there is a downturn or an emergency, you can’t use it to pay employees, suppliers and other expenses.

This restriction can be frustrating for companies that are growing. Imagine passing on a large order because regular cash flow cannot cover the costs. Meanwhile, you have six months’ worth of expenses sitting in a bank account apparently “doing nothing.”

The bottom line is that holding a cash reserve can and will affect your ability to grow. And the larger the reserve, the larger the impact on growth. It’s the tradeoff between safety and growth.

There is, however, an alternative for managing this problem.

Use financing to grow while you build a reserve

One way to keep a reserve and grow at the same time is to use external financing. For ideas on how to finance your company, read my previous article, “Eight Ways to Finance Your Glass Business” (August 2015 issue, page 26). With this strategy, your company builds a cash reserve from profits, while using external financing to help with new orders. If the economy takes a downturn, you can dial back the financing and use your cash reserve.

Keep in mind that financing does come with a cost. Therefore, it will affect your profit margins. Use financing strategically. Fund low-margin projects and orders using your own cash flow. Meanwhile, deploy external financing only for more profitable orders.

The author is managing director of Commercial Capital LLC, a factoring company and leading provider of invoice financing to companies in the glass industry. He can be reached at 877/300-3258.