Depicted in countless movies and TV shows as nothing more than a porcelain piggy bank tucked away in the back of the cupboard or on top of the fridge, most people are familiar with the notion of a “rainy day fund.” What many are unaware of, however, is just how sizable a piggy bank major organizations and businesses keep on hand just in case a financial thunderstorm rolls in unexpectedly. A more formal title for essentially the same monetary stopgap, cash reserves are a key component of both personal and corporate finance. Let’s take a look at why cash reserves are a fiscal no-brainer for employees and employers alike.
What is a cash reserve?
A cash reserve refers to money an individual or entity sets aside for emergency or unexpected expenses. Liquidity is an essential factor when it comes to a cash reserve; the funds need to be easily and readily attainable on short notice. With this in mind, a cash reserve doesn’t have to necessarily be limited to strictly cold hard cash. Short-term investments featuring quick liquidity options such as treasury bills and money market funds can be included in cash reserves as well.
Why is a cash reserve a good idea?
For any number of firms, organizations, and businesses, a cash reserve is a guarantee the company will meet all foreseeable financial obligations on the horizon. Just how far that horizon stretches depends on the size and stability of the business. Newer startups may only have cash reserves to cover a few weeks, while more established companies usually carry liquid assets capable of sustaining operating expenses for up to six months. Some of the biggest brands in the world like Google and Apple boast billions in cash reserves.
Moreover, a cash reserve also serves as a failsafe of sorts for firms in the event of any unexpected expenses or budgetary setbacks. For example, if a company fails to meet its Q4 profit projections, a hefty cash reserve in its proverbial backpocket helps ensure the business will have more than enough financial leeway to get back on track by Q1 the following year.
Cash reserves also come in handy for businesses interested in making a major acquisition or investment. Opportunities, just like expenses, often arise unexpectedly in business. Perhaps a competitor has faltered in recent years and is suddenly ripe for acquisition. Alternatively, maybe the chance to attract an entirely new user base presents itself organically. Access to cash or assets that can be liquidated quickly afford companies the capacity to take advantage of such opportunities.
Why you need a cash reserve too
It’s advisable for an individual to always maintain a healthy cash reserve for many of the same reasons a business should. Akin to the stereotypical piggy bank only to be broken during financial emergencies, a cash reserve can be a safety net in the event of an unexpected layoff or other life event that impedes the flow of cash into a household. Troublingly, recent research tells us about one in three Americans currently owe more in credit card debt than they have in a rainy day fund.
As mentioned earlier, besides plain old dollars and cents, a cash reserve can also include largely stable, short-term investments like treasury bills or certificates of deposit. The key here is liquidity; one must be able to access their case reserve in a hasty manner if necessary. Stocks generally aren’t included in cash reserves due to their more volatile nature.
How long should your cash reserve last?
One of the biggest challenges associated with cash reserves is striking the right balance between fiscal responsibility and hoarding. While a healthy cash reserve is always a good idea, money is at its most helpful when we put it to work for us in pursuit of further funds. A huge cash reserve represents a safer choice than more volatile options like stocks, bonds, and gold, but long-term returns will likely be smaller as well.
So, while a cash reserve is important, it should be just one aspect of the successful professional’s financial portfolio. That being said, it’s generally recommended for people to have enough funds to cover anywhere from 3 to 6 months of personal expenses. Any more than that, and it’s probably worth exploring other portfolio diversification options.
How to reach your cash reserve goal
Attempting to accumulate a meaningful cash reserve can feel near impossible amid the everrising cost of living nowadays. While everyone’s financial reality and income situation is going to vary, it can be helpful to open a separate savings (preferably high-yield) account for your cash reserve. From there, determine just how large a figure you’d like to eventually amass, and then allocate a portion of your earnings every month to your new savings account. Doing so may mean a little less spending money today, but a dependable cash reserve ensures a comfortable tomorrow.
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