Are you paying yourself enough?
One way to look at this question is your cash. If your cash is building, that’s great, of course. But, to a point. If you let too much cash build in your business, then it’s a sign that you’re not paying yourself enough. And when this happens, it has a negative impact on your company’s value.
That’s right, too much cash is not good. Your job is to build value in your business. You want to run your business as if you plan on selling it tomorrow. And you want the highest price possible for the sale. This means you want to show your investor or partner or buyer that your business is really worth something. And too much cash takes away from that worth.
There are many factors to consider when valuing a business. But one of the more popular metrics is Return on Assets. This is calculated by taking your net income before taxes (excluding interest) and dividing it by your company’s total assets. It displays how good a job you do making use of the assets in your company. Each year the idea is to show that you are growing this return. So if a company has $1,000,000 in assets and its income before taxes is $100,000, it has a 10% return. By the way – that’s a really good return! Most companies are doing well if their Return on Assets is at least more than a 30 year U.S. Treasury yield, which is currently around 2.5%.
Now suppose you let cash build up in your business. So that next year you have the same income of $100,000 but now you’ve got $1,050,000 in assets because your cash balance went up $50,000. Your return on assets has fallen to 9.5%. That’s not what you want. You want this number to go up. Which means you need to pay yourself more.
But how much cash should you be keeping in your business? You can figure this out by doing a Days Cash on Hand calculation. For this, you take your total cash divided by (operating expenses (excluding depreciation) divided by 365 days).
Here’s how this works. Assume your net operating expenses are $900,000 per year. If you divide by 365 then it’s $2,466 per day. If you’ve got $750,000 of cash in the bank then that means you’ve got 304.1 days cash on hand. That’s just too much. A typical business should have anywhere between three to six months of cash on hand. The rest is just dragging down your Return on Assets.
Cash is good. Too much cash is not. If you’re carrying too much, you’re killing your company’s value. Increase your paycheck, pay a bonus or distribute the money to your owners. Then take the money and invest it personally. You want to show yourself, and anyone on the outside, that you are running a lean and mean organization.