Why your business needs a cash buffer, and how big

Most owners have an instinct for how much cash feels safe. Few have it written down. The difference matters the day a big customer pays late, a tax bill lands, or a partner wants a distribution.

A cash buffer, or working-capital buffer, is the amount of cash the business commits to keeping at all times. Everything above it is genuinely available. Everything below it is the business's own operating float.

What a buffer protects

• Payroll. Wages go out whether or not the month's receipts have arrived.
• Lumpy obligations. GST, PAYG, super and tax instalments, which arrive on their own calendar.
• Slow payers. One large customer paying a month late shouldn't put payroll at risk.
• The owners. A buffer stops a profitable business being run hand to mouth, and stops payouts that have to be borrowed back.

How to size it

There's no single right number, but there is a sensible way to reach one.

1. Work out a typical month's costs. Smooth it over several months so a one-off spike doesn't distort the answer.
2. Choose a multiple. A business with steady, fast-paying customers needs less. One with lumpy revenue, long payment terms or a big payroll needs more. Two to three months of costs is a common starting point to react to.
3. Add a reserve for known risks. For example a large customer concentration, a seasonal trough, or debt falling due in the next twelve months.
4. Write it down and review it. Once a quarter, compare the buffer with what's actually in the bank.

What it makes easy

With a buffer agreed, the question "what can I take out?" has an answer. Run the numbers on your closed month, take the buffer off, and what's left is the amount in play. Whether to pay it out, and how, is then a decision for the directors, with the tax side handled by your tax agent.

The buffer is half of a pair. The other half is a dividend policy, which sets the tests a payout has to pass. Our free guide explains both, and the decisions that are yours to make.

General information only, not tax, legal or financial product advice. Your registered tax or BAS agent handles tax and your activity statements.

Want to know where your business stands?

The free Financial Health Check: read-only Xero access for 48 hours, your score out of 100, your top three priorities and what each is costing you, and a 30-minute call. Request it here.

Keep reading

• A budget nobody reports against is just a guess
• Will you have enough cash in eight weeks' time?
• How much can I safely take out of my company?
• Is your month actually closed?
• Have you outgrown a year-end-only accountant?
• Profitable, but no cash: where it goes
• All guides and articles