Why you should stop stockpiling cash and start building a hedge instead

Despite the fact that most small business owners have a number in mind for how much cash they should keep on hand, a few can actually explain where that number came from. The answer often has less to do with the size of the reserve and more to do with how that money could be working instead.

On today’s episode of Strategic Edge, Jay Abraham, Executive Coach and Founder and CEO of the Abraham Group, says that habit is quietly costing business owners growth. He says owners should shift their focus from stockpiling cash to lining up other options, including lines of credit, to call on before a crisis ever hits. 

The problem with a gut-feeling reserve

Business owners often set a cash reserve target out of instinct rather than analysis, Abraham said. The number feels safe, but it rarely connects to anything measurable about the business itself.

"I think a lot of SMB type entrepreneurs have an unintentional and unknowing sort of a reactive, defensive mentality." 

That defensive posture leads owners to hold onto cash without asking what it should be doing for the business instead. Abraham said the real question isn’t how much to keep, but how that money is best put to use.

What holding cash actually costs

Cash sitting untouched in a bank account earns close to nothing. Deployed the right way, that same money can return multiples of its value, Abraham said.

He pointed to his own company as an example. Abraham said his business regularly puts $20,000 to $30,000 toward marketing and advertising and sees returns as high as $300,000.

“Why would I want to keep that from being deployed, just worrying about a rainy day?” Abraham said.

A business owner worried about an emergency is often better served by a line of credit than a large idle reserve, he said. Abraham pointed to a lesson from management consultant Peter Drucker: if a business isn’t constantly working to find better, safer or faster ways of doing things, its competitors will do that work instead, at the business’s expense.

Holding cash back from experimentation and reinvestment isn’t a safeguard, Abraham said. It carries its own kind of risk.

Why a hedge matters more than cash reserves

Three months of reserves is typically adequate for most small businesses, Abraham said. That figure shifts depending on how a business generates revenue.

A company that relies on advertising, salespeople, distribution channels or trade shows faces a different cash flow rhythm than one that doesn’t, he said. Each of those revenue paths changes how much cushion actually makes sense.

Abraham said most owners never calculate what their reserve is costing them in lost yield. He reframed the conversation around what he calls cash flow architecture, the way money moves into a business, stays there and grows over time.

"I would argue that the hedge should be developed more so than the reserve."

Building that hedge means lining up options before a crisis hits. That can include securing a line of credit, arranging factoring, negotiating better vendor terms or setting up prepayment agreements. Those options need to be locked in ahead of time, since banks and vendors are far less willing to extend credit once a business urgently needs it.

Spread your risk around

The businesses most exposed to cash flow trouble often rely on a single source of revenue, Abraham said.

“If your revenue is coming from one source or one person, if you’re a small business, maybe you have one salesperson; if he or she leaves, you’re screwed,” he said.

Diversifying reduces that exposure, Abraham said. Partnerships, joint ventures, co-branding and referral networks spread risk across multiple channels instead of one.

Economic uncertainty is adding pressure, including elevated interest rates and geopolitical tensions. Abraham said more business owners are reconsidering their cash position. Many are asking whether that cash is working hard enough for them.