Risk Management

Metric of the Month: Days Cash on Hand

Strong cash reserves help you prepare for the unexpected — whether good or bad.
Perry D. Wiggins, CPASeptember 3, 2019

This month’s metric, days cash on hand, measures the number of days that an organization can continue paying its operating expenses with the amount of cash currently available. If sales revenue suddenly dried up or an unexpected catastrophe interrupted the business, an organization with substantial cash on hand would be able to keep running longer without incurring additional debt or having to raise additional funds. This liquidity metric is a valuable one for any finance chief, especially those in a moderate-to-high expense environment.

I learned the importance of this metric firsthand when Hurricane Harvey struck Houston in the fall of 2017. APQC’s offices — along with many other businesses and homes — suffered significant damage. The first floor of our offices took on nearly four feet of water and our building suffered damages in excess of $2 million. In the aftermath of the disaster, our strong cash reserves meant that we could secure a contractor for repairs to our building immediately, just as demand for contractors was beginning to spike across Houston. Having enough cash on hand sped up our recovery significantly and allowed us to continue operating with minimal disruption and without having to wait for an insurance payout or to secure a loan for repairs.

Your organization may not be in an area vulnerable to disasters like a hurricane, but every organization should be prepared for the very worst occurrences. APQC’s Open Standards Benchmarking data for days cash on hand shows that some organizations are, unfortunately, only prepared for minimal disruption at best. Bottom performers, for example, only have enough cash on hand to cover two months of operating expenses (see chart below). That certainly doesn’t leave much breathing room for an organization in the midst of recovering from a natural disaster or trying to launch a new product line when sales from the old line are declining. Top performers, which average 120 days cash on hand or more, would be able to cover their operating expenses twice as long.

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As with any key performance indicator, APQC recommends benchmarking a company’s performance for this metric relative to organizations of a similar size, complexity, and industry because the optimal amount of cash on hand will vary. Here at APQC, we strive to have at least 180 days cash on hand, though we currently have more than 365. In health care, where organizations often have to wait for reimbursement from insurance companies, 270 days (about 9 months) is a good number. In other industries, a business might need as little as three months to stay afloat without additional revenue. It is incumbent on leadership to establish the right amount of cash reserves to ensure that the business can keep running in the event of a downturn or disaster.

Having enough cash on hand isn’t only about being in a good defensive position — it’s also about being ready to take advantage of opportunities that your organization rarely finds available. If your company is struggling to improve its cash reserves, for example, it may not be in a position to take advantage of mergers and acquisitions, business expansion opportunities, or opportunities to increase its key employee base to manage growth. Having enough cash on hand can help ensure that you can capitalize on those opportunities immediately and without having to raise additional funds.

If your cash reserves are lower than you want them to be, there are at least three ways to increase them. The first is to examine your days sales outstanding (DSO). If it is unusually high for your industry (i.e., it takes a long time to collect from your customers) work to reduce it by renegotiating payment terms with customers and optimizing the invoicing process. Second, and especially if you already have a good DSO, increasing sales will help bring more cash into the organization. Third, because days cash on hand is tied to operating expenses, you should track closely what you’re spending in each area of the business and find ways to trim back. Ensure that your expense growth trails behind revenue growth and streamline your spend to make your cash on hand stretch further.

As important as it is to have strong cash reserves, building up those reserves should never supersede the need to run the business. CFOs should be prepared for whatever might come but should never allow cash reserves to become a hindrance to funding areas of the business that have a higher growth return. It would be counterproductive at best to slow growth or ignore high-growth areas of the business simply to have more reserve cash.

Ideally, an organization will not need to run solely on its cash reserves for long, but unforeseen disasters or downturns rarely come with a timetable that tells an organization when things will return to normal. More cash on hand means less disruption and more breathing room for the business to keep daily operations running until revenue returns. It also means the ability to take advantage of business opportunities without having to secure a loan or raise additional money from investors. An organization with strong cash reserves is ready to respond quickly to the unexpected — whether good or bad.

Perry D. Wiggins, CPA, is CFO, secretary, and treasurer for APQC, a nonprofit benchmarking and best practices research organization based in Houston, Texas.