Building a Cash Cushion: Practical Systems for Founders

The sale is on the books. The cash is not in the account. Rent does not wait for the deposit.

That gap is the reason to build a cash cushion. A business cash reserve is cash you can use when the checking account would otherwise miss a bill. FDIC Money Smart for Small Business describes it as a fund for business needs. It works like a personal savings account that belongs to the company.

What the cushion is for

A cash buffer for a small business covers a named problem. The sources do not share one list. Read them side by side before you move money.

The split matters. If you treat every slow week as an emergency, the fund never refills. If you refuse to touch it during a seasonal dip, you may miss payroll while cash sits in savings. Write the rule in one sentence and keep it with the account.

Cash runway basics start from the same choice. Runway is how many months the cash lasts if you follow that rule. SCORE’s gross burn is the monthly spending you use when you assume sales stop. Divide the reserve by that monthly number. The result is the months you can cover.

How to calculate the reserve

Founder cash reserve math uses the cash reports you keep. SCORE’s checklist starts with twelve months of cash-flow reports. A new business uses twelve months of projections instead.

Separate cash in from cash out

SCORE mentor Hal Shelton splits the two sides in a SCORE article on reserves.

Gross burn is cash you spend. Shelton’s illustration is thirty thousand dollars of expenses. He treats that as the conservative figure because it assumes no sales.

Net burn is cash from sales minus cash spent. In the same illustration, fifty thousand dollars of sales and thirty thousand dollars of expenses produce a positive net of twenty thousand dollars. A positive net feels safe. It assumes the sales arrive in cash that month.

The SBA’s manage-your-finances page shows why the timing matters. A two-hundred-dollar sale in January that the customer pays in February lands on January’s books under accrual. It lands on February’s books under the cash method. Accrual can show a result the checking account cannot pay. The cushion follows the cash date.

That SCORE article points to payroll and rent as the costs that rank as the largest in many businesses. SCORE says those costs are more predictable than revenue because many of them stay fixed. A startup should split one-time costs to open from the costs that continue after opening. The cushion is for the continuing costs. The opening costs need their own funding plan.

Build the monthly number

The SCORE checklist tells you to average the essential costs. Its list includes:

• Rent or a mortgage
• Utilities
• Business insurance
• Payroll and benefits
• Taxes
• Loan payments
• Other costs you must pay even if income stops

Shelton’s SCORE article says the cash has to cover salaries, including your own. The checklist asks what personal income could replace your salary, such as a spouse’s pay or personal savings. Do not count the same living cost twice. If the business must pay you, put that pay in the business number. If another source covers your living costs, leave it out of the business reserve and note the source.

FDIC Money Smart’s example target is three to six months of operating expenses. The SCORE checklist calls three to six months of essential costs a useful average. It says you may need more when the business is seasonal or the industry is volatile or personal resources are thin. FDIC Money Smart says to ask an accountant or another trusted adviser, and to start small.

Match the months to the time it takes to raise cash

Shelton’s SCORE article says the reserve should cover the wait for the next dollar, not a generic slogan.

• Money in an account you control can be a check or a sold investment. Shelton’s range is three to five days.
• A bank loan can take about two months in his example. One month to find a willing bank. One month for the paperwork. If spending is fifty thousand dollars a month, his illustration keeps one hundred thousand dollars. He then subtracts sales you are confident will arrive during those two months.
• Angel funding can take six to nine months in his illustration. At fifty thousand dollars of monthly spending, the example reserve is three hundred thousand dollars.

Those dollar figures are his examples. They are not a target for your account. Use your gross burn and your real funding path. A founder who can write a check needs a shorter operating cash reserve than a founder who must pitch investors.

Be conservative on the sales side. The SCORE article says actual results rarely match the forecast. FDIC Money Smart says to avoid an optimistic revenue guess and to include hidden costs. An SBA post on business metrics says to list the checking balance and the money you expect in the next thirty days and the bills you expect to pay. That thirty-day view is the early warning. A positive view is when you decide how much to hold for a slow stretch.

Where to keep it

Maintain a cash reserve in an account you can open in an emergency. The SCORE checklist adds a second test. The account should be hard enough to reach that you do not spend it on a normal Tuesday.

The SBA’s savings guidance says to put savings in the budget the way you put rent in the budget. Many owners work from one deposit to the next. The change is treating the transfer as a bill.

Keep this pot separate from a retirement plan. The SBA says a qualified plan can shelter current profits because contributions are deductible. Penalties and other rules make the money hard to use before retirement. That pot is for retirement. It is a weak emergency account. SCORE’s checklist mentions a retirement fund among personal resources some owners consider. Read that next to the SBA warning before you treat retirement money as the cushion.

Bankrate says a dedicated business checking account helps you manage cash flow and keeps the business records clean for tax time. The reserve can sit beside that checking account. The operating account pays the bills. The reserve account waits.

How to fill the cushion

FDIC Money Smart gives two moves. Send a percentage of profits to the reserve each month. Or cut costs you do not need and send the savings.

The SCORE checklist is more specific on the first move. Put 10 percent to 30 percent of business profits into the fund each month. Automate the transfer. The percentage applies to profit. A month with no profit does not produce that transfer.

When margins are tight, the same checklist lists other ways to fund the account:

• Raise prices.
• Ask clients for payment up front or for a deposit.
• Speed up collection of unpaid customer bills.
• Put a windfall such as a tax refund into the fund.
• Cut subscriptions and business travel and memberships and equipment you do not need.
• Ask suppliers for a lower price.
• Shop for cheaper business services.
• Move to a cheaper space or sublet part of the space.

An SBA post on supplier terms describes a related way to protect the cash you have. Net 30 means you pay a supplier thirty days after the purchase. Longer terms such as net 45 or net 60 or net 90 leave the cash in your account for more days. Pair that with customer payments on a shorter cycle. The SBA lists deposits and early-pay discounts and invoices sent at once and cash on delivery for slow payers. If you pay a supplier with a card to gain a few more days, the SBA says to pay the card in full when the statement is due. Interest on a carried balance spends the cushion you are trying to build.

A line of credit is a backstop, not the cushion itself. The SCORE article says the useful time to arrange one is when you do not need it. You can compare offers. FDIC Money Smart says that if a loan payment is at risk, talk to the lender early. Silence is the move that closes options.

Borrowing to skip the reserve has a cost the SBA names. You pay interest. You pay principal and interest each month before the project brings cash in. A loan can arrive too late for a deal that will not wait. Savings you hold do not need a lender’s permission.

The report that keeps the number honest

A cash flow cushion is only as real as the report under it.

FDIC Money Smart separates two reports. A cash-flow statement looks backward. It shows cash that moved. A projection looks forward. FDIC calls that projection a pro forma. The statement can be the base for the projection.

Both reports can split cash into operating activity and investing activity and financing activity. Operating items include sales and the costs of running the work. Investing items include buying or selling equipment. Financing items include loans and loan payments and money paid to owners. Ending cash equals beginning cash plus the net change. That ending figure is the cash the business holds.

FDIC Money Smart says projections help you avoid a shortage and decide how to grow. An SBA post on everyday planning says the point of a forecast is the way you run the business. Each month, compare what happened with what you expected. If sales rise, adjust inventory. If sales fall, adjust spending. A different SBA post says to review a short list of metrics on a quarterly check. That list includes the cash forecast.

Bankrate ties the habit to a first-year milestone. Positive cash flow is what lets you pay vendors and employees and yourself on time. Review the books on a schedule. If a margin is thin, change the price or the overhead. At the end of a year, replace hypothetical figures with the revenue and the costs you recorded.

Bankrate’s guide to bank reconciliation is the accuracy check. Match the ledger to the bank statement. Add deposits that have not cleared. Subtract checks that have not cleared. Enter interest the bank paid and fees the bank charged. Many businesses do this monthly, after the statement arrives. A high volume of transactions or a higher fraud risk can call for a shorter cycle. Bankrate says some businesses reconcile daily. The matched balance is the cash you can plan with.

FDIC Money Smart says accounting software can track the transactions so the cash picture stays current. A spreadsheet can hold the projection. FDIC says you can rebuild its template in a sheet with formulas. QuickBooks Online is one place to keep the reconciled balance and the categories in the same file. You decide which costs are essential. The software does not set the months of reserve.

Too little cash and too much cash

SCORE says two problems show up near the top of many lists of business failures. One is too little cash. The other is too much.

Too little cash is the missed payroll and the deal you cannot accept. The SBA’s savings post says a surplus is what lets you act without waiting on a lender.

Too much cash has its own damage. Shelton’s SCORE article says companies with extra cash hire and buy equipment and move to larger offices. They skip the planning they used when cash was tight. Those choices create new fixed costs. If cash sits above the forecast, the article says to distribute it to the owners rather than spend it into a permanent bill.

Growth can drain a cushion even when sales are rising. The SCORE article says receivables and sometimes inventory grow before the customer pays. You spend to make the sale. The customer pays after that spend. A reserve that ignores that lag will look fine on a profit report and fail on payday.

Pitfalls

• One number for every business. Three to six months is an example in FDIC Money Smart and a common average in the SCORE checklist. Shelton says using it everywhere misleads.
• A reserve built on hoped-for sales. Gross burn ignores those sales. Use it when you want the conservative cushion.
• No written rule for withdrawals. SCORE’s checklist and FDIC Money Smart do not match. Write yours down.
• Sales tax used as a float. FDIC Money Smart says to avoid that. Penalties for late tax payments can be severe.
• A retirement account treated as the operating reserve. The SBA says those funds are hard to use before retirement.
• A line of credit opened in a panic. SCORE says to explore it while you can compare terms.
• A forecast you never reconcile. Bankrate says the ledger and the bank need to show the same cash.
• Vendor payments you delay without an agreement. FDIC Money Smart says late payments can strain the supplier relationship. Negotiate the term. Do not skip the bill.

Set the system this month

1. Pull twelve months of cash-flow reports. If the business is new, use twelve months of projections. SCORE’s checklist starts there.
2. Average the essential costs. Note gross burn beside it.
3. Choose the months from your funding path and from seasonality. Ask an adviser if you are unsure. FDIC Money Smart makes that suggestion.
4. Write one sentence on what can empty the account.
5. Open a separate account that you can reach in a crisis and that you will not tap for ordinary bills.
6. Automate a transfer from profit. Use the SCORE range of 10 percent to 30 percent if the month produced a profit. Start smaller if FDIC’s “start small” fits this year.
7. Each month, reconcile the bank account and compare the cash forecast with what happened. The SBA’s thirty-day list is the short view. Ending cash is the number you protect.

If those reports live in QuickBooks Online, read the ending cash after the reconciliation. A sheet works when the volume is light. Either way, the cushion is the cash you set aside on purpose and the rule that keeps it there.

The month you can pay the bills without the customer’s check is the month the system is working.