Would your company be able to survive a major unexpected expense? Are you prepared for financial hardships or opportunities that come your way? Regardless of the size of your business, it’s important you have a war chest that’s stocked and easy to access.
What is a war chest?
As defined by Will Kenton of Investopedia, a war chest is “a colloquial term for the reserves of cash set aside or built up by a company to take advantage of an unexpected opportunity.” Having this extra capital set aside for unforeseen expenses — whether good or bad — can provide the wiggle room that small or mid-size businesses like yours need to continue thriving.
Storing your war chest
You shouldn’t have all of your cash tied up in investments you can’t access when you’re in a pinch. That’s why Paul Tracy of Investing Answers points out most businesses store this cash in short term and liquid investments.
Otherwise, you may end up having to quickly borrow money from a lender, which could result in a high-interest loan that does more harm than good for your business.
Common uses for war chests
It’s important you know what expenses are worth disbursing your war chest to cover and which are not. You don’t want to deplete your emergency fund on costs that aren’t true emergencies.
Good uses of a war chest include buying out a competitor, launching a new product, and hiring employees to cover a sudden surge in business. On the flip side, you may encounter adverse situations that require fast cash. Economic expert Dave Manuel lists protecting your company from a hostile takeover, and funding an expensive legal battle as two worthwhile ways to spend your war chest.
Know your business’ numbers and start low
How much money you should siphon into your war chest every month depends on your specific company and its unique situation. Be careful not to pick an arbitrary amount with no consideration of how much cash your company needs to operate on a daily basis — or to pick an amount that’s too aggressive and could put you in a bind.
Ben Walker of accounting firm Inspire advises taking a good look at your company’s average profit. Then, start siphoning off a small amount each month. “It’s best to start your contributions off at around 5% — see how the business reacts. Keep your finger on the pulse. Does the heart keep beating steadily when you up it to 10-15% a couple of months later? … Adjust accordingly, when you find equilibrium, stick with it.”
Keep your war chest reasonable
A word of caution: There is such a thing as too big of a war chest.
Having a surplus of capital can be commonplace if your business is flourishing, but that doesn’t mean all of it should be going into your war chest. Only a reasonable portion of your profit should be funneled into the war chest every month. And if it ever grows to a point that it contains more cash than you would ever reasonably need, it’s time to cap that fund until you’ve spent it.
Having an unreasonably large war chest is an unwise use of available capital and should be reinvested into business development, market expansions, or bonuses for your employees. Walker recommends capping your war chest at three months’ worth of your business’ normal operating funds.
Make sure your business’ extra money isn’t fully invested all the time. Retaining a portion of it in an emergency reserve can give you the flexibility you need to overcome short-term hardships or advance your operations to new heights.