Back in June, we talked a bit about solvency. One of the best ways to maintain solvency is to have a healthy amount of reserves, and to use them judiciously.
Clients often ask me what I consider to be a healthy amount of reserves for their organization. My typical answer is that it really varies based upon their particular enterprise’s goals and needs. Many enterprises operate without much in the way of reserves at all, and this ends up constricting and restricting their options when finances get tight. Nevertheless, long-term solvency is often dependent on having healthy levels of reserves.
In order to set a healthy reserve target, consider answering the following questions:
- How much money do we need to make up the difference between our lows in income and our highs in expenses? (Basic cash flow cushion)
- What sorts of emergencies could put us out of business if we don’t have the funds to cover them right away?
- Do we foresee any major new initiatives from which we may want to draw down savings in order to start them?
- If we lost our major source of revenue, how long would it take to wind down our affairs and go out of business? How much would this cost?
- Are we dependent on any cash for investment revenue?
- What assets can we sell to raise cash if needed?
Adding up the amounts these six questions generate can help begin to generate a reserve target.
Do you have any additions or subtractions to this list? What has worked for you?