Up until recently, most business owners didn’t need to think about what would happen if they suddenly stopped trading entirely. But these days we’re all more acutely aware of the importance of having a backup plan, particularly as we enter what looks like a long recession.
Because of this, it’s important to calculate your cash cover to help you understand your business’s position if your finances unexpectedly go south. But what exactly is cash cover and how do you measure it?
What is cash cover?
Your cash cover is the fixed cost of running a business vs its bank balance every month. Essentially, it’s how much money you would have left in the bank in case of emergency – for example, a worldwide pandemic – and how long your business would be able to survive on it.
Ideally, you should have two to three months minimum as a cash reserve, and many businesses will need to build it back up after a crisis. There are many reasons to measure your money, and calculating your cash cover will tell you how big of a safety net you’d be likely to have in a worst case scenario situation.
How to calculate your cash cover
The first step in determining your business’s cash cover is reviewing your business’s financial statements.
Focusing on your business’s revenue and expenses, as well as your cashflow statements from the previous year, should give you the information you need to identify how much you earned and how much you spent.
Once you have those numbers to hand, you can subtract your expenses from your revenue to reveal how much went towards business costs such as payroll, rent and other costs in the past year.
For example, let’s say your business had a turnover of £96,000 last year and your expenses totalled £72,000. That leaves you with £24,000 in reserve.
Next, you’ll need to divide your expenses (£72,000) by the number of months in the period (12) to find your monthly cash burn rate – in this case £6,000.
Finally, divide your reserve (£24,000) by your monthly cash burn rate (£6,000) to find out how many months your business could survive without any income. In this case, the business would be able to keep running for around four months.
These calculations can be complicated, and you won’t necessarily have the same costs each year, but they should give you a good idea of how long your business would last without revenue.
Benefits of calculating and tracking your cash cover
Keeping an eye on your cash cover can soften the blow if things go wrong. Calculating your reserves will give you a greater understanding of your business’s financial health and help prevent you from coming up against cashflow problems in the future.
Furthermore, if you discover that you don’t have enough to last you two to three months, you’ll be able to look at your expenditure and take the necessary steps to build a better financial safety net.
Alternatively, you may find that you have enough money to last you much longer than that. While it’s important to have a healthy amount in your back pocket, a high cash reserve may indicate that you’re not reinvesting enough into your business.
Want to secure your business’s financial future? Talk to us today to find out how our team of financial advisors can help.