How many months of cash should a business have? Work out your number in Xero

Short answer: most small businesses should keep three to six months of fixed costs in cash. Three months is enough if sales are steady, spread over many customers, and you have an overdraft you could use. Six months or more is safer if sales are seasonal or lumpy, one customer is a big share of sales, or the business pays your own living costs. Two things matter as much as the number of months. Count fixed costs (what you would still pay if sales stopped), not every expense; fixed and variable costs shows how to tell them apart. And count only cash that is yours: GST or VAT you have collected, payroll taxes you owe and money put aside for income tax all sit in the bank but belong to someone else.

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Months of cash is not the same as cash runway

These two questions sound alike but answer different worries:

• Cash reserve (this guide): if sales stopped or halved for a while, how many months could you keep paying the bills you cannot switch off? It is a target you set and save towards.
• Cash runway: at the pace cash has actually been falling, when does it run out? It only applies when the bank balance is going down month after month, which is one of the first warning signs of cash flow problems. The free cash runway calculator works it out from your balance, costs and income. To see which week in the next quarter cash runs lowest, build a 13-week cash flow forecast.

A profitable business can have a long runway and still be one lost customer away from trouble, which is what the reserve is for.

How many months? A quick way to choose

Start at three months and add to it for each thing that makes your sales less certain:

Your situation	Months of fixed costs
Steady repeat sales, many customers, an overdraft you could draw on	3
Seasonal sales, or your quietest three months are well below average (seasonal business cash flow works out the exact amount)	4 to 6
One customer is more than a quarter of your sales	add 1 to 2
Long projects, or customers who pay in 60 days or more	add 1
A newer business, or it pays your own living costs	6 to 12

These are rules of thumb, not a law. The point is to be able to survive the bad patch you can actually imagine: your worst season, losing your biggest customer, or a large customer paying three months late.

How to work out your number in Xero

1. Find your monthly fixed costs. Run the Profit and Loss for the last 12 complete months as one column. Take total costs, leave out depreciation (it is not cash), and split the rest into costs that stop when sales stop (materials, subcontractors, freelancers, commission) and costs that do not (wages, rent, leases, insurance, software, loan repayments). Divide the fixed part by 12. Loan repayments are not on the Profit and Loss at all, except the interest, so add the principal you repay each month.
2. Find your bank balance. Run the Balance Sheet for today and add up the bank accounts. Only trust it if the accounts are reconciled; if Xero and the bank disagree, see Xero bank balance doesn’t match the bank first.
3. Take off money that is not yours. On the same Balance Sheet, under current liabilities: the GST or VAT account, payroll taxes (PAYG withholding, PAYE or similar) and super or pension owed. Then take off what you have set aside for income tax, which often is not in Xero until your accountant posts it. What is left is your free cash.
4. Divide. Free cash divided by monthly fixed costs is how many months of cash you really have.
5. Check how bad a bad patch gets. Run the Profit and Loss by month for the last 12 months and find your weakest three months in a row. Then run Income by Contact (or the sales by customer report in your version) to see what share of sales your biggest customer is; the customer concentration calculator works it out, with what losing them would cost. Use both with the table above to pick your target.

For the next few weeks rather than months, Xero’s short-term cash flow shows bills and invoices due in the next 30 days.

A worked example: a design studio with $62,000 in the bank

A six-person design studio has $62,000 across its bank accounts. Over the last 12 months it spent an average of $30,000 a month (not counting depreciation), so the owner thinks: “two months of cash, fine.”

Splitting the costs:

Monthly cost	Average	Fixed?
Wages	$18,000	Yes
Rent	$3,500	Yes
Software, insurance, other	$2,500	Yes
Freelancers and printing	$6,000	No, these stop when work stops
Total	$30,000	$24,000 fixed

And the money in the bank that is not the studio’s:

Owed or set aside	Amount
GST/VAT collected, due next quarter	$9,400
Payroll taxes and super/pension due	$4,600
Income tax set aside	$12,000
Total not yours	$26,000

Free cash is $62,000 minus $26,000, or $36,000. Divided by $24,000 of fixed costs, that is 1.5 months, not two. The headline number flattered the studio twice: it counted tax money as its own, and it would also have been too pessimistic about freelancers, who stop being a cost when work dries up.

To choose a target: the Profit and Loss by month shows the studio’s quietest three months were 35% below average, and its biggest client is 40% of sales. From the table, that is three months, plus one for the big client, and the seasonal dip argues for at least four. Four months of fixed costs is $96,000 of free cash, so the bank balance should sit around $122,000 when the usual $26,000 of tax money is in it.

The gap is $60,000, which is too much to close at once. The owner sets three months ($72,000) as the first milestone, a $36,000 gap, and moves $3,000 a month into a separate savings account: twelve months to get there. The Aged Receivables report also shows $18,000 more than 30 days overdue. Collecting half of that is three months of saving in one go, which is why who owes me money is often the fastest way to build a reserve.

How to build the reserve

• Pay it first. A fixed transfer to a separate account each month, sized from what the business really earns. How much can I pay myself? works out what is left after tax, loan repayments and the cushion.
• Collect faster. Every day you take off how long customers take to pay frees cash. The debtor days calculator shows how much, and how to improve cash flow ranks it against paying suppliers on terms and holding less stock.
• Keep tax money apart. Moving GST/VAT and income tax to their own account each month makes the main balance honest.
• Look at the fixed costs. Every $1,000 a month of fixed cost you remove lowers the target by $3,000 to $6,000. Where is my money going? ranks a year of costs.

Common questions

Is three months of cash enough for a small business? For a business with steady repeat sales, many customers and an overdraft it could use, three months of fixed costs is usually enough. If sales are seasonal, one customer is a large share of sales, or customers pay slowly, aim for four to six.

Should I count GST or VAT in my cash reserve? No. GST or VAT you have collected is owed to the tax office at the next return, so take it off the bank balance before working out how many months you have. The same goes for payroll taxes you owe and money set aside for income tax.

Does an overdraft count as a cash reserve? Treat it as a backup, not as the reserve. A bank can reduce or withdraw an overdraft, and it is most likely to do so when your figures look worse, which is exactly when you would need it.

Should the cash reserve be in a separate account? It helps. Money in the main account tends to get spent, and a separate savings account shows at a glance whether the reserve is growing. It still counts as your cash in Xero as long as the account is set up as a bank account there.

Should I use total costs or fixed costs? Fixed costs. The reserve is for a period when sales are down, and costs that move with sales, such as materials, subcontractors and commission, fall with them. Using total costs makes the target larger than it needs to be; using only the bank balance without taking off tax money makes it look closer than it is.

Seeing your cash every Monday

ReportPilot reads your Xero figures and sends a short plain-English email every Monday. It shows the bank balance against last month end, and when cash has fallen in two of the last three months it says how long the cash lasts at the recent pace and roughly which month that is. It also covers profit, who owes you and bills due soon, so you notice the reserve shrinking while there is still time to act. It asks Xero for read-only access, and there is a 14-day free trial with no card.