A cash reserve is money a company or individual should have in order to pay for short-term, urgent, or emergency expenses. In a crisis, whether that be an emergency situation, a family death or illness, or loss of job and income, you want to have extra cash to get you through until the crisis is over. This financial safety net guarantees your protection during financial emergencies.

Cash reserves can also be held in a short-term, highly liquid investment account that earns a low annual percentage. An individual can open a mutual fund to both grow and keep the money they may need quick access to. A significant cash reserve can also serve as a large purchase fund. Instead of acquiring a loan or paying over time, this cash reserve can be used to may a lump sum up front.

A company needs to have a cash reserve that is fairly liquid in order to meet the cost of both expected and unexpected costs. This cash on hand should also be used for company investments. Cash is the most liquid form of wealth, but there are other things such as Treasury bills, that are short-term enough to be considered cash reserves. They have a high frequency of exchange and near-maturation date.

Individuals

Individuals in securing financial stability should set aside money in an emergency fund, also called a reserve fund. This allows you easy access to money in the future if necessary. In the meantime, it will earn interest until you have an unexpected or extravagant expense.

A cash reserve should be approximately the amount of money necessary to cover three to six months of your expenses. These expenses may include:

  1. Mortgage/rent payments
  2. Disability protection
  3. Your child’s expenses
  4. Car payments
  5. Security
  6. Health expenses (insurance, co-pays, prescriptions)

Without an emergency fund, an event like unemployment or disability could be financially devastating. Look at your family’s and your financial needs and determine how much money you need in your cash reserve account.

Small Business

Businesses should look at their expenses and income to decide how much money to keep in cash reserve. If the company has been established for a little while now and you have past expenses and income reports, review those.

Step by Step

  1. Review your cash flow statement from the previous year to determine how much money you spent
  2. Subtract your expenses
  3. Multiple this “money burn rate” by the number of months you want your cash reserve money to cover.

If you are not established, or fairly new, use projected cash flow and expenses to do the same. Make sure you look at all your business expenses:

  1. Materials
  2. Employee pay
  3. Overhead
  4. Rent
  5. Utilities
  6. Insurance

Large Businesses and Corporations

Some large corporations have cash reserves in the hundreds of billions.

Banks, for example, have to have very large amounts of money, mandated by the U.S. Federal Reserve, to protect your money. The amount is determined as a percentage of liabilities. These cash reserves must be held in cash or deposits.

How to Save

If you have not saved for a cash reserve yet, or are having trouble, here are some tips to get you going:

  1. Save, save, save
  2. Budget savings as a part of your expenses each month
  3. Reduce wasteful spending (eat out less, rent free movies at home, don’t gamble, etc.)
  4. When spending, use cash, or other liquid assets, not credit
  5. Use profit from investments

You don’t have to create this case reserve quickly, it may take six months or even a year, but make sure you are taking strong steps towards saving for it each and every day. If it helps, make your deposit into your cash reserve account automatic every month out of your pay check. Consider using a business savings account, as it will earn interest as the amount increases.

Once you have saved enough in your cash reserve account, you can stop saving for that account, and start saving in other ways with the peace of mind that your cash reserve account is full.

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