When is the matter of how much cash you have at your disposal of critical importance?
- Your sales revenues suddenly plummet
- An unexpected catastrophe hits your business
Under such circumstances this liquidity metric tells you how long you will be able to cover operating expenses. If cash on hand is substantial, your business can keep running longer without incurring additional debt or raising additional funds. Especially if you are operating in a moderate-to-high expense environment, this metric is important.
What will you do if a hurricane or flood strikes
The author of an article published on the cfo.com website recalls how his company suffered massive damage during a hurricane. After this disaster, the company's strong cash reserves enabled the hiring of contractors to carry out necessary repairs immediately. The fact there was enough cash on hand helped the business to recover quickly so the disruption to operations was minimal.
If you don’t have enough cash on hand, there are two options:
- Wait for an insurance payout
- Take out a loan or find another source of funding
Optimal amount of cash on hand varies
For how long should you be able to cover your operating expenses? Even two months can be a rather short time span. Top performers are usually able to go on for four months or longer. You should benchmark this metric relative to organisations of a similar size, complexity and industry.
Even if you aren’t at risk of natural disasters, you should still be prepared for the very worst. Imagine trying to launch a new product line when you suddenly observe how sales and revenues from your current line are disappearing fast.
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