Every entrepreneur starts a business with an optimistic approach. From expanding the customer base to maximizing profits – they outline goals to set up the company for future success. Undoubtedly, having an optimistic viewpoint is imperative, but you shouldn’t ignore the bitter realities of the business world. Today, rising economic instability is disrupting the corporate landscape. Even well-established businesses are facing difficulty in managing routine expenses.
Similarly, the persistent fluctuations in global interest rates have increased the debt burden on entrepreneurs. In other words, running a business in the 21st century has become more challenging than ever. Therefore, entrepreneurs must maintain a robust financial standing to remain operational in the marketplace. Besides initial invested capital, you have to set some money aside for the rainy days in cash reserves.
Instead of using all business profits, you have to put some amount in the reserve fund. By the end of every year, it would have enough money to cover potential losses, keeping your business afloat. Are you still wondering what the purpose of maintaining reserves is? Here we are unfolding five reasons why companies must maintain reserves.
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Strengthens Financial Position
Most entrepreneurs only concentrate on fulfilling financial obligations without acknowledging the risk of losses. You might be clearing credit card dues and utility bills with incoming profits, but what if your business drowns in losses? Recently, the global pandemic has led to the closure of well-established companies only because they didn’t have a solid financial standing. Reserves provide a cushion, allowing companies to remain operational despite revenue and income generation.
If you are unsure from where to fund the reserves, learn the art of crunching numbers. You can always look up online but for a better understanding, complete an MBA with accounting concentration to understand finances inside out. You will learn how to cut back on business costs, helping you set aside 20%-30% of profits for the reserve fund. It will strengthen your company’s financial position, securing it from potential losses while ensuring growth.
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Finances Capital Expenditures
Sometimes, opportunities come knocking on the doors, but entrepreneurs cannot capitalize on them because of insufficient funds. Perhaps, you might find a reputable client who is looking for a new accounting firm. Likewise, market research can unfold demand for a new product in the market. Cash reserves can provide funding for all such expenditures. From covering the acquisition cost of a new client to purchasing machinery for product development – reserves can finance substantial capital expenditures.
Moreover, if a business wants to expand production capacity, it can utilize the reserves to install new plants. In addition to fulfilling capital needs, having a reserve fund eliminates the need for external financing. Hence, companies would no longer have to fill out loan applications and spend thousands of dollars on interest payments.
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Pays Out Dividends
Usually, when profits are running low, companies end up not paying the dividends. It might sound reasonable, but not getting annual dividends can greatly upset the shareholders. Some even think of selling their shares since their investment isn’t getting returns. Similarly, the new investors won’t be willing to invest in the company because of your inability to offer returns. Surprisingly, things can be a lot different when you have sufficient cash in the reserve fund.
You can utilize that money to pay annual dividends to shareholders and maintain your company’s reputation. However, if reserves don’t have enough cash to pay dividends for every shareholder, opt for an interim dividend. It will let you pay the dividend semi-annually, reducing the financial burden without upsetting the shareholders. Besides, you can also use reserves to buy back the company’s share and increase the percentage of your ownership in the business.
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Maintains Working Capital
Working capital is the difference between current liabilities and assets, reflecting how much money the business has after covering liabilities. Hence, if the working capital turns negative, the entire company would be at risk of a liquidity crisis. In such situations, reserves come into play. You can put additional cash into the business that would increase current assets and working capital.
Likewise, you can also use the reserve fund to cover up accrued bills and payments to reduce current liabilities. Alongside bringing immediate cash into the business, it will keep working capital at the required level.
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Funds Overdrafts
Is your company’s bank balance always in overdraft? Many entrepreneurs have a habit of swiping credit cards for unnecessary expenses. As a result, they end up spending more than their earning potential, and the credit card bill keeps accumulating. In addition to increasing current liabilities, persistent overdrafts can weaken a company’s financial position. Fortunately, having a reserves fund can help you clear up the overdraft payments.
You can take out your bank statements, reconcile them with financial statements, and cover the bills altogether. It eliminates the risk of liquidity problems and decreases the burden of liabilities on businesses. However, having a reserve fund doesn’t mean you can keep accumulating bills; instead, entrepreneurs have to spend wisely.
Wrapping Up
In today’s business world, maintaining a reserve fund has become inevitable for every business. It promises financial stability and secures companies from losses, ensuring long-term success. Likewise, reserves also help companies remain operational by funding for working capital. Besides this, if the company cannot pay dividends or has substantial bank overdrafts, reserves can compensate for all the expenses. Thus, invest some money in the reserve fund to make your business flourish in the longer run.
