Cash reserves refers to an amount of money on hand specifically intended to deal with emergencies.
These are typically short-term emergencies, but as the last few years have taught us, a few weeks doesn't always pan out how we think. Another use for reserves is to forge the future of your business, including;
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Expanding to new markets
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Offering additional services
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And other growth opportunities
Of course, the question at hand is how does an MSP manage to build their cash reserve? The first step is to track key metrics that allow you to understand your cash situation.
Track the Right Metrics for an Accurate Cash Reserve
There are a number of metrics, dozens in fact, MSPs track to measure the success of various aspects of their business. We cover several in another article. That said, there are three particular key performance indicators (KPIs) that allows you to either:
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Clearly see the condition of your cash-building ability
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Directly improve the cash flow of your business (assisting in increasing your reserves)
Accounts Receivable (A/R)
Late payments are a prevalent problem in the world of small business, at large. A few of the most concerning stats include:
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Nearly 4 in 10 invoices go late (source)
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Incorrect invoices cause over half of late payments (same source as above)
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The most recent number suggests 70% of businesses still use paper invoices (source)
Staying on top of your A/R is usually at the top of mind for MSPs. After all, invoices are commonly large and as a service, interactions with clients are more frequent than other business models.
However, big invoices (especially paper) take longer to process, pay, and are more prone to mistakes.
Suggestion: Beef up your A/R process, consider switching to digital invoicing, and even use an accounting service to build out an A/R automation system.
Months of Cash (or "Runway")
In the startup Software-as-a-Service (SaaS) world, businesses who receive venture capital must track their runway. Runway is the amount of cash in the bank, added to the monthly recurring revenue (MRR), subtracted by the average monthly operating expenses.
MSPs track a similar metric, typically called "Months of Cash."
Depending on how you consider it, your cash reserve could be calculated in terms of how many months you can survive off of that number. Essentially, it's a "rainy day" fund to see how long you can survive a downturn or unexpected issue affecting your book of business.
Effective Hourly Rate
How you price and package your services varies from one MSP to another, but your team costs a set amount (either hourly or salary). That average number hovers around $31 per hour, or nearly $68k per year.
It's a good idea to closely track your effective hourly rate by taking the amount of serviceable hours spent on clients versus your service income --- regardless of whether or not you bill hourly, via set prices, or a recurring revenue model.
Build Recurring Service Revenue
Speaking of recurring revenue, it's a great pivot that allows you to grow your cash reserve. An MSP has hardware sales, big ad hoc projects, and regular services as the three main revenue drivers.
Which one of those sounds the most consistent (in terms of revenue)?
In another article, we went for a deep dive into why building recurring revenue is important for your business. Let's quickly cover how this type of model helps build your cash reserve.
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Builds a foundation to grow cash reserves: Contracts and set monthly fees for clients means a reliable income, from month-to-month. Having your expenses covered by recurring revenue means when ad hoc projects and large sales come through, it's easier to build reserves.
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Creates stability which leads to consistency: The stability offered by set, regular fees gives you more dials to control your business. Should growth occur quickly, you're in a better position to hire and move quickly. During a downturn, you understand exactly how and where you're bloated.
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Improves client quality (over time): After 6 months to a couple of years, your client roster fills with customers who understand your recurring value and continue onward with you. Poor quality clients fall off by attrition.
Beyond the Rainy Day (Set Goals for Cash on Hand)
Cash reserves for MSPs aren't all about the rainy days. Once you have your target number of months of cash on hand, you can (and should) continue to build out available cash to focus on growing your business.
The ability to launch new services, enter new markets, and hire ahead of need are big differentiating factors for growth.
No matter which stage you're in, building reserves to weather storms, or saving to take your MSP to the next level --- the professionals at Sundack CPA are experts in assisting MSPs and ready to hear about your specific goals. Get in touch with us today.