Business leaders plan ahead to protect every aspect of the business. They get insurance, they hire specialists to manage taxes, legal and compliance issues, and they make spare sets of keys for their shop. Businesses should also protect their financial runway – and reserve accounts can help with this.

Even though many business owners know that stockpiling a healthy cash reserve is good practice, most still aren't doing it. JPMorgan conducted a study of 597,000 small businesses and found that 25% held a reserve covering fewer than 13 days of doing business, if other revenue dried up.

Here's what business owners need to know about what reserve accounts are, why they're important and how to build up the right size of reserve account to protect your business against unforeseen expenses or dips in revenue.

What's in this article?

• What is a reserve account?
  
• Why businesses need cash reserves
  
• How much cash reserve should you have for your business?
  
• How to calculate your cash reserve goal
  
• How Stripe reserve accounts work
  

What is a reserve account?

A reserve account (also known as a "cash reserve") contains a back-up supply of funds that are set aside in case your business needs extra cash in the future. A reserve account is like your business's emergency fund.

Reserve-account funds are most often in the form of cash, but not always. A reserve account can be any funds that you're able to liquidate and access quickly. Short-term investments, such as money market funds, can also be used in reserve accounts, as these can be converted into cash easily and at short notice.

Why businesses need cash reserves

Cash reserves are an important part of any business's financial plan for the same reason that individual emergency funds are important in our personal lives: unexpected expenses might suddenly occur or there might be an unforeseen dip in revenue. Reserve accounts represent your business's financial insurance policy.

Reserve accounts are valuable for all businesses, but for many small business owners, a financial rough patch could affect their personal finances.

Take the COVID-19 pandemic, for example. Overnight, thousands of businesses were suddenly unable to operate due to lockdowns – and thousands more were operationally limited because their business models conflicted with safety measures. Data gathered by Yelp shows that nearly 98,000 businesses closed for good because of the pandemic.

The pandemic is a clear example of a sudden, dramatic disruption that affected countless businesses. Reserve accounts provide important, extra insurance policies that can keep small businesses solvent when unexpected barriers pop up.

But small businesses aren't the only companies that find reserve accounts useful. Here are some reasons why reserve accounts are important to platforms, SaaS businesses and enterprise businesses:

• Financial stability
  Reserve accounts provide a financial cushion and increase the stability of the business. They act as a safety net, allowing the company to weather unexpected expenses, economic downturns or unforeseen circumstances, without jeopardising its operations.

• Risk mitigation
  By maintaining reserve accounts, businesses can mitigate risks associated with potential cash flow issues. These reserves can cover short-term funding gaps, such as delayed payments from customers or unexpected expenses, reducing the risk of financial instability.

• Expansion and growth
  Reserve accounts can support business expansion and growth initiatives. Businesses can use them to fund new projects, invest in research and development, or explore market opportunities. Having reserves in place allows businesses to take calculated risks and pursue growth strategies, without relying solely on external funding sources.

• Operational continuity
  For SaaS businesses and platforms, reserve accounts ensure uninterrupted service provision. Reserve funds can maintain server infrastructure, cover operational costs during lean periods or allow for investment in technology upgrades. This helps to sustain the quality and reliability of services offered to customers.

• Investment opportunities
  Having reserves allows businesses to seize investment opportunities that arise unexpectedly. They provide the flexibility to capitalise on strategic partnerships, mergers, acquisitions or other ventures that can contribute to long-term growth and competitiveness.

• Compliance and regulatory requirements
  Reserve accounts may be necessary to comply with certain regulatory or legal obligations. For example, financial institutions may be required to maintain reserve accounts as part of their regulatory compliance, ensuring that they have sufficient capital to absorb potential losses and meet regulatory standards.

• Investor confidence
  Reserve accounts demonstrate responsible financial management and fiscal discipline. They can enhance investor confidence by showcasing the business's ability to navigate financial challenges and ensure its long-term sustainability. This can be particularly important for attracting investors, securing funding or negotiating favourable terms with stakeholders.

• Refund management
  Reserve accounts also help businesses to withstand a sudden influx of chargebacks or refund requests. Let's say that hundreds of transactions are revealed to be fraudulent and refunds need to be issued immediately – this can disrupt cash flow severely. Or perhaps a new product has a flaw that requires sending refunds and processing returns. Reserve accounts can cover businesses in these situations.

How much cash reserve should you have for your business?

How much of a cash buffer do you need to have? Typically, most small businesses should have a reserve account with enough money to cover their operating expenses for three to six months. For larger companies, the answer is more complicated.

Let's discuss reserve accounts for small businesses in a bit more detail. The amount you need in your reserve account depends on several factors relating to your business. According to the JPMorgan study, the median cash reserve for small businesses is around US$12,000, but there are significant variations between different industries. For example, high-tech manufacturing companies tend to keep more than US$34,000 in reserve on any given day, while personal services businesses hold on to a cash balance of only US$5,300, on average.

Ask these questions when you're deciding on a savings goal for your reserve account:

• How much cash does your business use every month?
  Make sure that you consider fixed, variable and seasonal expenses.

• What is the minimum amount of cash that you need to hand to maintain essential business operations?
  This is a good number to know – and regularly update – about your business anyway.

• What other sources of cash are currently available to your business?
  Aside from actual cash savings, do you have any other assets that could be liquidated quickly, if needed? Include those in this exercise.

Now, let's talk about larger businesses, where the considerations for reserve accounts are different. When determining the amount of funds to keep in a reserve account for a large business, ask the following questions:

• What are the potential risks and uncertainties that could affect your business?
  Assess the specific risks that your business may face, such as economic downturns, market fluctuations, industry-specific challenges or regulatory changes. Consider the likelihood and potential impact of these risks on your operations.

• What are the historical patterns of cash flow in your business?
  Review your historical cash flow statements to understand the typical ebbs and flows of cash in your business. Identify periods of high cash flow, low cash flow and any seasonal variations. This analysis can help you to estimate the minimum amount needed to cover operational expenses during lean periods.

• What are your fixed and variable expenses?
  Identify the essential fixed expenses that your business incurs on a regular basis, such as rent, salaries, utilities and insurance. Also, consider variable expenses that may fluctuate based on sales volume or other factors. This evaluation will help you to determine the baseline amount required to cover these expenses.

• Do you have any significant expenses or investments coming up?
  Consider any upcoming capital expenditures, planned expansions or investments in technology, infrastructure or marketing initiatives. These expenses should be factored into the reserve calculation to ensure that sufficient funds are available to support these initiatives.

• How long would it take to recover from a financial setback?
  Assess the potential impact of a financial setback, such as a decline in sales, loss of a major client or unexpected expenses. Estimate the time it would take to recover from such setbacks and the reserve amount needed to sustain the business during the recovery period.

• What are the industry standards and benchmarks?
  Research industry benchmarks and best practices for maintaining reserve funds. Compare your business to organisations of a similar size, and which have a similar revenue and risk profile. This analysis can provide insights into the typical reserve levels that are considered to be appropriate within your industry.

• What are the regulatory or legal requirements?
  Determine if there are any specific regulations or legal requirements that dictate the minimum reserve levels for your business. Factor compliance with these obligations into your reserve calculation.

• What are the growth objectives and future plans for the business?
  Consider the growth trajectory and strategic plans for your business. Assess the potential investment opportunities, expansion initiatives or new product development plans that may require additional funds. Ensure that your reserve calculation accounts for these future aspirations.

How to calculate your cash reserve goal

To calculate the target amount to save in your reserve account (or in addition to your existing cash reserves), look at your overall cash flow throughout the year. Review your monthly cash flow statements to see how much money is going in and out of the business every month and over the course of the year. Looking at annual cash flow will account for seasonal fluctuations in operating expenses.

Once you have a clear picture of your business's burn rate (the amount of money that you spend on running your business), you can calculate how much cash it would take to keep your business going for three to six months if, for any reason, revenue stopped temporarily. It's unlikely that your cash flow will stop completely. However, basing your target reserve amount on that scenario will cover your business if it ever does happen.

Once you have your target cash reserve amount in mind, subtract whatever cash you already have in reserve, along with the value of any investments or other assets that could be liquidated quickly. Your target amount minus what you currently have is the amount that you will aim to save and add to your reserve account.

How Stripe reserve accounts work

Stripe is always looking for additional ways to support businesses, including employing reserve accounts. In some cases, Stripe will start building up a reserve account for users if it looks like the business has an elevated risk of customers requesting refunds or disputing charges. Some factors that could trigger the creation of a reserve account for a business include:

• Industry conditions
  
• Payment activity
  
• Dispute rate
  
• Refund rate
  

Reserve accounts with Stripe provide a financial buffer that businesses can use to ensure that adequate funds are available to cover any potential refunds or chargebacks. Stripe notifies businesses when a reserve is placed on their account, and it regularly reassesses conditions to determine if and when it would be appropriate to remove the reserve.