The standard personal-finance answer — three to six months of expenses — is a starting point, not a plan, because business revenues fail differently than salaries. A restaurant can lose 40 percent of sales in a quarter because a highway project rerouted traffic; a firm with one client covering 70 percent of revenue can lose most of its income from a single procurement decision. Federal Reserve research has repeatedly found that most businesses would struggle to cover even two months of expenses from cash alone, and that fragility, not profitability, is what ends firms in downturns. Orer News publishes information, not financial advice.
The right number is a function of two things: how concentrated your revenue is, and how fast you can cut costs when revenue drops. Both are measurable.
What determines the right size?
Start with concentration. No client above 15 percent of revenue and a diversified customer base behaves more like a salary — three months of essential expenses is a defensible floor. One client above 50 percent, or a sector with seasonal collapse, argues for six months or more. Then adjust for cost flexibility: payroll-heavy businesses with long-tenured staff cut slowly and need more reserve; asset-light solo operations where the owner can throttle spending quickly need less. Contract obligations — lease terms, insurance prepayments, debt service — set the hard floor, because those payments continue regardless of revenue.
What counts as essential expenses?
Count only what keeps the entity alive and able to reopen at full strength: payroll for the people you cannot lose, rent and debt service, insurance, software that holds customer data, tax deposits, and minimum inventory to serve remaining demand. A reserve sized against total spending including discretionary marketing is overfunded; one sized against rent alone is a wish. Most owners land between 60 and 80 percent of normal monthly operating cost as the right baseline figure.
Where should the reserve actually sit?
Liquid and boring: a business savings account, money-market fund, or Treasury bills laddered to maturity dates matching payroll cycles. The reserve's job is availability, not yield — an illiquid investment that must be sold at a loss in exactly the month revenues collapse fails the purpose. Keep it in a separate account so it is not silently spent by normal operations, and document in your operating agreement or internal policy what triggers a draw, because a reserve without a withdrawal rule becomes a slush fund by the second quarter.
How do you build it without starving growth?
Fund it from a fixed percentage of collections — even 2 to 5 percent per month reaches a three-month reserve within two to three years at typical margins — and from windfalls: tax refunds, one-time large contracts, asset sales. Alternatively, pair a smaller cash reserve with an undrawn line of credit, which is cheaper to hold but is not guaranteed in a downturn: credit lines can be re-priced or reduced by the lender exactly when they are most needed, a lesson repeated in every credit tightening. Cash you hold is yours; credit you might borrow is the bank's decision.
What else buys the same protection?
Reserves are one tool among several. Business interruption and key-person insurance transfer part of the risk; receivables discipline shortens how long a shock takes to reach you; a documented cost-cutting plan — what gets reduced in week four versus month three — converts panic into sequence. The reserve covers what insurance does not and speed cannot.
- Six months for concentrated revenue, three for diversified
- Count essential costs only — typically 60–80% of operating spend
- Hold it liquid, separate, with a written draw rule
- A credit line complements cash; it does not replace it
A reserve is insurance you pay yourself. The exact number matters less than the fact that it was computed, funded on a schedule, and defended against the first attractive excuse to spend it.
For more context, read Why a Separate Business Bank Account Pays for Itself.
For more context, read The Real Cost of a First Hire, Itemized.
For more context, read business credit card.