Company cash requirements / ideal cash levels

[Trailhead]

Hi all

How do you go about calculating the cash on hand a business requires?

Net working capital tells me £1M (debtors £1.2m plus stock £700k less payables of £900k)

Payables days are 66 days, receivables 60 days and stock is 70 days but not sure how relevant this is.

However this seems like a crazy amount of cash to keep on hand. And net cash flow each month is positive so this £1m will continue to grow and not get used up.

I can see how £1m would be the case for a new business start up in the first month to two months, but for ongoing established company’s should incremental calculations based on the above be used instead?

Or something else such as a typical month of cash flow and then taking x1 or x2? This doesn’t seem very scientific.

Thoughts welcomed or advice on how you set your target bank balance appreciated.

[anonymous-user]

I presume you are asking this as you are trying to evaluate another business?

The cash available in a business has I think two main drivers. Firstly, how much do you think you need to survive a downturn? This varies of course by business, but I would say most business owners are well aware that things can sometimes turn bad quite quickly. So having more cash in the business gives the safety net of time, allowing the owners time to fix any serious issues which arise.

For me personally, I like to know I could survive a significant business shock by having sufficient cash in the business so that I could operate normally for around a year.

The second driver is what else they intend to do with the money. It might be they want to save up for a large purchase, or they are planning to sell and use their retained profit as a type of pension pot. So there are a whole variety of reasons why you would keep what might seem a large amount of cash on hand.