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How Much Cash is Enough?

(Warning: This post includes math. If you wish to stick your head in the sand and stay away from all things math, do so now.)

This is a big question at the end of the year for pretty much all retailers, especially us seasonal retailers. We’re flush with cash from the big Christmas season. We’re thinking we want to give ourselves a nice bonus, possibly pay down a loan, or even bonus the employees who worked so hard.

We just want to make sure we have enough cash for the upcoming year. But how much cash is enough?

You need to calculate two numbers – Current Ratio and Cash-to-Current Liabilities Ratio.

To do that, you need a Balance Sheet from January 1st. Your accounting software can easily print that for you. (If you don’t have any accounting software, take some of that cash and invest in Quickbooks and a class on how to use Quickbooks – it will pay for itself in one year!)

On your Balance Sheet locate these three numbers.

  • Current Assets
  • Cash
  • Current Liabilities

The Current Ratio is calculated like this:

Current Assets divided by Current Liabilities = Current Ratio

The answer will typically be shown as a number like 2.9. A good rule of thumb is to have a ratio of 1.5 or higher. Typically seasonal businesses at the end of their season will have a ratio around 3.0 or higher. If your number is around 3.0, that’s pretty good.

The Cash-to-Current Liabilities Ratio is calculated like this:

Cash divided by Current Liabilities = Cash-to-Current Liabilities Ratio

The answer will typically be shown as a percentage like 75%. For some businesses you would ideally like between 10-20%. But for seasonal businesses entering their slower season, you will want much more, as much as 70-80%. If you are a seasonal fourth quarter business, 75% is a good number to have right now.

Separately, the two numbers only tell part of the story. The key is to look at both together. If both numbers look good, then your only real worry is deciding what to do with the extra cash. If both numbers are weak, then you have some tough decisions to make to try to raise some cash and get cash flow under control.

But when one is weak and the other strong, there are a number of issues at play.

If the Current Ratio is strong but the Cash-to-Current Liabilities is weak, then you likely have too much inventory. That may be on purpose because you got a good buy or are planning an expansion or are growing inventory for the upcoming season. Or it may be that you bought too much last year and are carrying excess inventory. It might be time to have a sale.

If your Current Ratio is weak but Cash-to-Current Liabilities is strong, you need to start writing orders and building up your inventory.

The math isn’t that hard to do. The results, however, tell you a lot about the health of your business. Don’t ever be afraid of the Math.

-Phil Wrzesinski

PS If you are a summer seasonal business go pull your Balance Sheet from the end of your season and do those calculations from there. If you are not a seasonal business (doing 40% or more of your annual business in one quarter), then you don’t need the big build-up of cash so those numbers can be much lower. Just keep an eye on them each month.

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