If business owners have learned anything during the COVID-19 pandemic, it’s that having backup funds available is important during emergencies. Having cash on hand means an owner can access lines of credit, pay taxes and vendors on time, and have money for unexpected events.
While some businesses may not be in a position to save right now, it’s never too early to start planning for the future. Business owners need to have cash for immediate or short-term purposes like unexpected emergencies, as well as for longer-term needs such as buying equipment or having adequate cash savings to qualify for a business loan.
Here’s a rundown of some savings options to consider.
Three key short-term savings tools are checking, savings and money market accounts. Most small to medium-sized businesses should have money market and savings accounts to hold the excess cash that they do not expect to use in the near future, said Danny Chan, vice president and branch manager at East West Bank.
Operating a business means that cash needs can crop up unexpectedly, added Daren Blonski, co-founder and managing principal of Sonoma Wealth Advisors in California.
“Having liquid cash assets to help cover cash flow is critical to ensuring the long-term viability of your business,” Blonski said. “Understanding short-term savings options is an important aspect of financial management. Each of those types of accounts has different considerations for earning interest and ensuring accessibility.”
The cash in a business’s savings and checking accounts is good for short-term liquidity needs, such as paying employees and vendors and covering emergencies. Money market accounts, which pay higher interest rates but might also require minimum deposits, are highly liquid, but be sure to determine the terms prior to investing cash in them. Shop around to find the savings and money market accounts with the highest interest rates.
“Having cash on hand in the event of emergencies is critical to business success,” Blonski said. “I organize emergency cash into three categories: Short-term is kept in a savings account, medium-term is kept in a money-market account, while long-term money is maintained in highly liquid short-term securities.”
Before a company can add a new location or purchase another business, it is critical to establish plans for longer-term cash needs. Businesses need adequate savings to obtain business loans.
Businesses should use both short and long-term investment options to help build up their cash reserves. For shorter term investments, businesses can purchase short-term U.S. Treasury bills (which matures ranging from four weeks to one year) and mutual funds in stocks or bonds, Chan said. To save for longer-term plans that exceed 12 months, such as expanding to new locations or buying real estate, companies could invest in mutual funds, Treasury notes (which have a two to 10 year maturity), structured certificates of deposit (CDs) and other assets, he said.
Additionally, businesses can save on interest rate costs by paying down lines of credit with any additional cash, Chan suggested. “The interest rates on short-term investments and savings will always be less than the interest charged on their line of credit,” he explained.
Purchasing fixed assets such as real estate is a good way to not only invest in long-term capital gains, but also allows companies to build equity when they pay down the principal, Chan said. Even if the property value doesn’t rise, owners are still paying down their principal loan balance from using the property and avoiding fluctuations in rental prices. Not only that, the interest, property tax, and expenses of the property are typically tax write-offs.
“The business owner may also be able to claim depreciation on the useful life of the building, tenant improvement and furniture, fixtures and equipment,” Chan said. “Keep in mind that depreciation is more of a tax deferral than tax write-off if the building is sold at a price higher than value after depreciation.”
John Blake, CPA and partner at accounting and advisory firm Klatzkin, added that businesses can also use fixed assets such as machinery and equipment, furniture and fixtures, and computers that are necessary to operate your business to lower their taxable income. “Think of machinery and equipment—if you have net income for the year and purchased a piece of equipment, you can expense the entire cost in the year of purchase, which will save the company tax dollars,” he said.
Business owners must invest in a robust accounting and financial system, Chan said.
“Some owners or CEOs are also great CFOs, but even the best CFO cannot work with bad accounting practices,” he said. “With a robust accounting system, the CFO can then analyze trends, working capital needs, cash flow and profitability.”
For small businesses, especially owners of pass-through entities such as sole proprietorships and LLCs, it is crucial to put money aside to pay taxes, including income and sales taxes, said Blake.
“I have had many small business owners not do this and when the end of the year would come, they would have to raid their emergency fund of cash to pay the tax liability,” Blake said.
Take budgeting seriously and plan for at least the next year. Avoid ordering too much inventory, Blake said. He also recommends keeping a close eye on your accounts receivable. “If customers are slow paying, find ways to speed up their collections,” he said.
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