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The cash cushion formula: how many months of cover has your business actually got?

The three numbers you need

Cash is what is in the bank today. Every owner knows this one, and on its own it tells you almost nothing.

Net cash is cash minus the near-term money that is already spoken for: the VAT you have collected but not yet paid over, PAYE, suppliers falling due. This is the number that is actually yours, and it is nearly always smaller than the bank balance, sometimes shockingly so.

Monthly cost base is what it costs to run the business for one month: payroll, rent, software, the lot. Not what you hope to spend, what you actually spend.

Divide net cash by monthly cost base and you have your cushion, in months. Months, not pounds, is the point. Pounds tell you what you have; months tell you how long you have.

A worked example, from Xero's own Demo Company

£10,000 in the bank means nothing on its own

My favourite question to ask about any bank balance is the Dublin one: so what? £10,000 in the account, so what? If your cost base is a thousand pounds a month, you have ten months of cushion and you can breathe. If your cost base is a hundred thousand pounds a month, the same £10,000 means things are going to get stressful, or already are. Same bank balance, opposite situations. Until you put your cost base next to your cash, you do not know which business you are running.

How much cash should a small business have?

There is no single number that fits every business, and anyone who gives you one without asking about your costs is guessing. But I can tell you what it looks like when it works. One client I worked with for five years ran, at almost every point in that period, with between one and two months of fixed cost base in the bank. That cushion is why the story is boring in the best way: the business took investment, paid its corporation tax and quarterly VAT on time, hired, bought stock, expanded when the moment came, and never borrowed, never factored an invoice, never went back for emergency equity.

The same chart rerun with £50,000 less in the bank touches zero, and the business is suddenly timing payments and thinking about an overdraft. Rerun with £200,000 less, it spends months below zero, and something significant has to change: borrow, raise, or abandon the plan. Same trading, same customers, same profits. The only difference is the cushion.

So the honest answer is: enough months of cost base that a normal shock, a VAT quarter, a slow-paying month, a customer wobble, does not force you into expensive decisions. For most of the businesses I work with that means comfortably more than one month, and under one month means the next shock chooses for you.

Why the net cash flow formula alone will not warn you

The textbook net cash flow formula, cash in minus cash out over a period, tells you which direction you moved last month. Useful, but it is a rear-view mirror: a business can post positive net cash flow for months and still be one VAT bill from trouble, because the formula says nothing about how much is in the tank. The cushion converts your position into time. Direction tells you how the last month went; months of cover tell you what you can survive next.

Where the formula stops being enough

• It is a snapshot, not a forecast. The cushion tells you where you stand today. If you are planning a hire, a raise or an expansion, you still need a forward view as well; the client in the video used both.
• Costs are lumpy. Corporation tax and quarterly VAT do not arrive in neat monthly twelfths. A 1.5-month cushion the week before a VAT quarter is not the same as one the week after.
• Seasonal businesses need to read it seasonally. Two months of cover going into your quiet season may be thin; the same two months going into your busy season may be plenty.
• It will not collect your debtors for you. The cushion tells you how urgent the chasing is. The chasing is still yours to do.

Checking it weekly without building a spreadsheet

Everything above you can do yourself in a spreadsheet, and if you will genuinely maintain one, do. What Own Your Numbers does is the maintaining: it connects to your Xero read-only, works out your cash, net cash, cost base and cushion, and sends you the answer every Monday with a risk rating and the five things to do about it. That is the Weekly Cash Score. It takes about a minute to read, and it cannot change anything in your Xero.

For accountants, bookkeepers and fractional FDs

The formula is also the fastest triage you can run across a client list: net cash over monthly cost base, every client, every Monday. You do not need a meeting to know which client to ring this week, the number tells you. Running it across a practice is its own page.