Maintaining a Cash Reserve

What is maintaining a cash reserve?

Maintaining a business cash reserve is analogous to maintaining a personal savings account. Just as your personal savings can act as a hedge against unforeseen financial problems (such as job loss or the death of a spouse), a business’s reserve cash can help the business get through changes in market demand and pay for unexpected business expenses. A cash reserve can also help your business be prepared for new business opportunities. Although maintaining a cash reserve is important, you should always bear in mind the opportunity cost of leaving cash idle.

What is cash flow, and how does it affect a cash reserve?

Cash flow is a measurement of the amount of cash flowing into and out of a business during a specific time period, such as a week or a month. At the end of the designated time period, if a business has received more cash than it has spent, it will have a positive cash flow. Particularly in the beginning stages of a business, cash is often the most important factor for ensuring success. If a company runs out of cash and can’t afford to meet current expenses, the business may go under. Unless your business has a positive cash flow, it can be difficult to establish a cash reserve savings account.

When should a cash reserve be established?

Your business’s ability to maintain a cash reserve will depend on its overall cash flow and the business life cycle stage at which it finds itself. Typically, businesses pass through four stages: start-up, growth, maturity, and decline. Start-up companies generally have very high expenses, and little or no cash flow and cash reserves, because the business has yet to make sales. If your business is at this stage you may not be able to afford much of a cash reserve at first, but you’ll definitely want to establish one as soon as your firm starts to generate sufficient cash.

During the growth and maturity stages, maintaining a cash reserve will be very important, both to hedge against unforeseen problems and to finance expansion through capital reinvestment. After consulting with your financial advisors, you should consider establishing a separate cash reserve account at a financial institution. Many commercial banks will offer a variety of cash reserve vehicles as well as some limited assistance with the cash management process.

How do you establish a cash reserve?

Cash reserve accounts are most often established at commercial banks. When considering various investment vehicles, you’ll need to balance accessibility to the money with interest rates. However, accessibility to the money should really be your primary consideration when choosing account types for your cash reserve funds.

If your cash reserve is relatively small, you’ll want to be able to access it when necessary without incurring a penalty. In the case of larger cash reserves, you may be able to place part of the money in accounts offering higher interest rates. Basically, there are three types of accounts that are most often used for holding the cash reserve funds of small businesses: (1) money market deposit accounts, (2) certificates of deposit and other term deposits, and (3) money market mutual funds or marketable securities. There are advantages and disadvantages to each.

It’s also possible to use credit as a source of emergency cash funds. However, the need to repay such loans, combined with high interest charges, should make this alternative less desirable than the cash reserve account. Nevertheless, it’s advisable to have a line of credit available for use when you need it.

Money market deposit accounts

The interest rates offered by money market deposit accounts are somewhat better than those offered by ordinary savings accounts, but are still fairly low. These accounts are FDIC-insured and provide immediate accessibility to funds. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 permanently increased the FDIC coverage limit. At a qualified institution, the FDIC now insures up to $250,000 per single-owner account and up to $250,000 per co-owner for joint accounts..

Certificates of deposit and other term deposits

Certificates of deposit (CDs) and other term deposits may provide better interest rates than do money market deposit accounts. However, the funds are not as easily accessible. More specifically, you need to wait until the term of the CD has expired before you can withdraw funds without incurring a penalty. Bank CDs are also FDIC-insured up to $250,000.

Remember that a CD is included when calculating a bank’s total FDIC coverage for a given owner. For example, if you have a money market deposit account and a CD at the same bank, both of which list you as the sole owner, the combined holdings would only be covered by the FDIC up to $250,000.

Money market mutual funds and marketable securities

Money market mutual funds and marketable securities frequently allow immediate access to funds, although you often must maintain a minimum balance in the account. If you go below the minimum balance, a penalty will be charged.

Unlike money market deposit accounts, money market mutual funds are not insured or guaranteed by the FDIC or any other government agency. Although money market mutual funds strive to maintain a $1 per share net asset value, there is no guarantee that they will do so. Before investing in a mutual fund, carefully consider its investment objectives, risks, fees, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing.

Non-interest bearing transaction accounts

Prior to December 31, 2012, as a provision of the Dodd-Frank Wall Street Reform Act, all funds in a noninterest-bearing transaction account were insured in full by the FDIC. This temporary unlimited coverage was in addition to, and separate from, the $250,000 coverage available to depositors under the FDIC’s general deposit insurance rules. The term noninterest-bearing transaction account includes a traditional checking account or demand deposit account on which the insured depository institution pays no interest. It does not include other accounts, such as traditional checking or demand deposit accounts that may earn interest, NOW accounts, and money-market deposit accounts. Now that the provision has expired, noninterest-bearing transaction accounts will be combined with other accounts at the same institution held by the same owner in determining the $250,000 total insurance limit.

What strategies can be used to build a cash reserve?

There are a number of ways to build a cash reserve. For instance, you can deposit a portion of the excess cash generated by your business into this account on a systematic basis. In addition, you can add a portion of the earnings from your business’s other investments to the account. You can also reduce spending and add the money saved to the reserve account.

It’s wise to vary your investments and to ladder maturity dates. For example, instead of investing all of your money in one-year certificates of deposit, invest in CDs with different maturity dates so they will come due at different times. Combine your CD investments with some marketable securities investments to obtain higher interest rates. Use a multi-tiered investment approach by combining a number of different cash reserve vehicles with a line of credit and perhaps a cash value life insurance policy. (This type of policy allows you the opportunity to build up cash that you can later withdraw for other uses. Keep in mind that loans or withdrawals will decrease the final payout.) Be sure to review your cash reserve account periodically and to adjust the balance of the account as needed.

Are there any disadvantages to maintaining a cash reserve?

Maintaining a cash reserve is as vital for a business as your own personal savings account is for you. Nevertheless, it is important to bear in mind the one great disadvantage: the opportunity cost involved when your cash remains relatively idle. Ideally, excess cash should be reinvested in your business or invested in long-term vehicles to strive for higher potential returns. Maintaining a cash reserve bank account deprives you of capital reinvestment money and probably generates a much smaller return than may be obtained otherwise.


Our CFS* Financial Advisors can guide you through setting priorities so you can take care of your family. Call us at 336.774.3400 to set up an appointment today!

*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. Allegacy Federal Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018

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