A cash flow buffer is money that a company keeps precisely so that an unexpected situation does not turn into a crisis. It is not an investment or idle cash in the account, but insurance that gives the owner time to think instead of reacting in panic.
In our survey, 30% of business owners said they would not immediately know where to find money if an unexpected cost or drop in sales occurred. Only 28% could say for sure how many months the company could keep going without new sales (read the survey summary).
Why you need a buffer
- A client pays late. One bigger late payment can delay salaries or taxes.
- Seasonality. Many companies have months with fewer sales while costs stay the same.
- An unexpected cost. A broken machine, a supplier price increase or replacing an employee.
- An opportunity. A good offer, a bigger order or a favourable purchase that needs money quickly.
How big should the buffer be
A common rule of thumb is to keep a buffer of at least 2–3 months of fixed costs: salaries including taxes, rent, leases, software and other costs that come even when there are no sales. The exact amount depends on the company:
- If revenue depends on a few big clients, you need a bigger buffer.
- If sales are seasonal, base it on the costs of the weakest period.
- If client payment terms are long, add at least one month of incoming payments to the buffer.
- If a big investment or tax payment is coming up, plan for it separately from the buffer.
How to build the buffer
- Calculate your monthly fixed costs. This is the basis for the size of the buffer.
- Keep the buffer in a separate account, so it doesn’t disappear among everyday payments.
- Set aside a fixed percentage of every incoming payment, until you reach your target.
- Don’t pay dividends before the buffer is in place. In Estonia, profit retained in the company is not taxed, so keeping the buffer in the company does not create extra tax.
- Keep an overdraft as a backup, not as a replacement for the buffer.
Two stories from our clients
Reverse Resources: growth without big investor money
Reverse Resources has been built largely by bootstrapping and with project funding rather than large investment capital. In a company like this, cash flow has to be especially visible, because every project and payment affects what the company can do next. Working with KL Raamatupidamine, the accounting of three countries and three business lines was brought together into one set of management information.
Now I feel so much more supported, because I no longer make these financial decisions alone.
Ann Runnel, founder and CEO of Reverse Resources (read the full story)
Talloelekter: the confidence that the accounting is in order
A buffer is not only money, but also knowing that the numbers are correct and someone is keeping an eye on them.
I know that my company’s accounting is in good hands.
Vallo Jõesaar, Talloelekter OÜ
How we can help
Part-time CFO prepares a cash flow forecast, calculates the right buffer size for your company and tracks every month how it is filling up. Financial controlling shows the cash reserve in months in the monthly management report. We also covered this topic in our webinar “Managing cash flow in a company’s growth phase”, and you can ask for the recording on the webinars page.
Example: calculating the buffer
Let’s say the company’s monthly fixed costs are as follows:
| Cost | Per month |
|---|---|
| Salaries including taxes | 8 000 € |
| Rent and utilities | 1 200 € |
| Leases and loan payments | 900 € |
| Software, telecoms, insurance and other | 600 € |
| Total fixed costs | 10 700 € |
A two-month buffer would then be about 21,400 euros and a three-month buffer about 32,100 euros. If the company has one big client who makes up half of revenue, or if sales are seasonal, it makes sense to keep a buffer closer to three months. (The example is illustrative.)
Where to keep the buffer
- A separate current account: the money is available immediately but doesn’t mix with everyday payments.
- A short-term deposit or savings account: part of the buffer can earn interest as long as it can be accessed quickly when needed.
- Not in shares or long-term investments: the point of a buffer is availability, not returns.
Frequently asked questions
Can an overdraft replace a buffer?
An overdraft is a good backup, but it is borrowed money that you pay interest on and that the bank can reduce by changing its terms. It is best to keep your own buffer with an overdraft alongside it.
Should the buffer be kept in the company or in the owner’s account?
In Estonia, profit retained in the company is not taxed, so keeping the buffer in the company makes sense from a tax perspective. If the money is taken out as a dividend, income tax is due on it.
What if there is no buffer and money is running short?
The first step is a cash flow forecast for the next 4–8 weeks. Then you can decide which payments to postpone, whom to reach agreements with and whether temporary financing is needed. The earlier this is done, the more options you have.
Summary
A cash flow buffer doesn’t make a company more profitable, but it prevents a good company from getting into trouble because of one late payment or a bad month. When you know how many months your company can hold out, you can make decisions calmly.
Free and with no obligation
A 30-minute review of your numbers
Let’s calculate together how big a cash flow buffer your company should have and how far you are from it right now.
- We go through your latest monthly income statement, balance sheet and cash flow together
- We show you where the most money and time is being lost
- You get 2–3 concrete next steps you can take yourself straight away
Book a time and send your latest monthly income statement and balance sheet to kaideliis@klraamatupidamine.ee before the call. If you don’t have reports, we’ll start with what you have.