When we ask small business owners about their biggest problems, a recurring theme is not having enough cash on hand to cover day-to-day expenses, unexpected issues, and long-term investments in their businesses.
In other words, they don’t have a strong cash position.
With a weak cash position, your small business is less liquid, and in a more vulnerable financial position.
So, it’s important to understand your cash position, and what it means in the context of your business.
Below, you’ll learn:
- What cash position is
- Why cash position is important
- How to calculate cash position using liquidity ratios
- The differences between cash position and cash flow
- How to determine what a good cash position looks like for your small business
Let’s get started.
Cash Position Definition
The cash position is the amount of cash your business has at a given moment in time relative to your expenses and liabilities. The most liquid assets such as treasury bills, money market funds, and other cash equivalents are often included in the cash position.
Why is Cash Position Important?
The cash position is important because it measures the liquidity position and financial strength of your business. It is an important indicator for investors and analysts to consider when evaluating a company, and for internal stakeholders who are responsible for the company’s financial position.
- A stable cash position increases the likelihood that a business can consistently cover its short term debt.
- A large cash position means that a business is financially strong and may be able to deploy cash for business growth.
- An excessive cash position may bring an opportunity cost with it, where the business leaves growth opportunities on the table and it makes more sense to invest the cash.
How to Calculate Cash Position
Quick Ratio = (Cash + Cash Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities
Current Ratio = Current Assets / Current Liabilities
As a rule of thumb, the higher the quick or current ratio, the stronger the cash position. A current ratio below one is often problematic for a business, while a quick ratio of below one can cause issues during tough economic times.
Since these ratios represent a moment in time and not a trend, cash position is usually measured over a period of time – such as monthly or quarterly. This provides a much better picture of the financial stability of the business.
Cash Position Example
Let’s consider a hypothetical business with current assets worth $75,000, of which $50,000 consists of cash and cash equivalents. The current liabilities are $50,000.
The current ratio amounts to $75,000 / $50,000 = 1.50.
The quick ratio amounts to $50,000 / $50,000 = 1.
So, does this business have a good or bad cash position?
You might not love this answer, but it depends. Now, let’s discuss what it depends on.
What is a Good Cash Position for a Small Business?
If your business’s current ratio and quick ratio are both greater than one, there’s a high likelihood that you have a good cash position. That’s because you have enough current assets and liquid assets to cover your current liabilities.
But the exact number that is considered “good” depends on the industry and the business model. There is also an element of risk appetite (how much risk you’re willing to take in order to achieve your objectives) and how much of a financial cushion you want to maintain.
One of the best ways to determine what a good cash position looks like for your small business is through comparisons with direct competitors in your industry. In more volatile industries, it often makes sense to aim for current ratios and quick ratios that are both well above one.
Cash Position vs Cash Flow: What’s the Difference?
Cash position and cash flow are related and both are used when evaluating a business, but they are not the same thing. Cash position represents the cash your business has at a moment in time, while cash flow refers to the net inflow or outflow of cash over time.
Cash position is better suited to measure your company’s liquidity position and financial strength, while cash flow is better suited to measure profitability.
Cash Position: The Bottom Line
Maintaining a healthy cash position is a good way to prevent your small business from running into financial problems during slow times.
A current ratio and quick ratio above one and a little higher than the industry average likely means that your business has a good cash position. But if you are unsure or your numbers aren’t so clear-cut, you may want to reach out to a trusted accountant or financial advisor to help evaluate your cash position.