What it means
Cash held in a current account is safe but usually earns very little, so holding too much quietly costs the business the return that money could have earned elsewhere. Holding too little risks missed payments, emergency borrowing at short notice and damaged supplier relationships.
The target balance is the deliberate middle point between those two costs. It is normally expressed either as a fixed dollar amount, as a number of days of operating outflow, or as a multiple of a typical month's payroll and supplier run.
Setting the target matters because it turns cash management from a daily scramble into a policy. Once a target exists, the treasury team can automate sweeps into deposit accounts, plan short-term investments with confidence, and give the board a simple test of whether cash is being managed or merely watched.
The right target depends on how predictable the business is. A subscription software company with monthly direct debits and stable costs can run on a thin buffer, whereas a construction contractor with lumpy milestone payments and seasonal work needs far more cover.
Many finance teams add a defined buffer on top of the base calculation for known irregular payments such as quarterly tax, annual insurance renewals or bonus rounds. A well-run policy also sets upper and lower trigger points, so the treasury team acts when the balance drifts rather than reacting only at the target itself.
In practice
Real-world examples.
Example
A veterinary group with eleven practices sets a target of $480,000, equal to about six weeks of costs. Anything above $550,000 is swept into a notice account each Friday, and anything below $420,000 triggers a review of receivables collection before the overdraft is touched.
Example
A seasonal garden centre sets two targets: $250,000 through the winter and $900,000 from March to June, when stock purchases and casual wages peak. The dual policy avoids holding peak-season cash for the whole year.
Example
A manufacturing subsidiary of a larger group is required to hold a target of only $75,000 locally, because surplus cash is swept nightly to the parent's central account and the group provides an intercompany facility for shortfalls.
Formula
Calculation
Target cash balance = (Average daily operating cash outflow x Days of cover required) + Buffer for known irregular payments
Cavendish Interiors expects total operating cash outflows of $7,200,000 over the coming year. Using a 360-day convention, average daily outflow is $7,200,000 / 360 = $20,000 a day.
The board's policy is 45 days of cover, giving a base requirement of $20,000 x 45 = $900,000. The finance team adds a buffer of $150,000 for the quarterly tax payment that falls due within the next cycle, so the target cash balance is $900,000 + $150,000 = $1,050,000.
At the end of the month, the actual bank balance is $1,400,000. The surplus of $1,400,000 - $1,050,000 = $350,000 is swept into a 30-day deposit account. At a 4% annual rate, holding that $350,000 on deposit for a month earns roughly $350,000 x 4% / 12 = $1,167 that the current account would not have paid.Case study
Seen in the real world.
This is an illustrative, fictional account. Rowan Park Foods, a chilled food supplier with revenue of about $34,000,000, historically held whatever cash happened to accumulate, typically between $2,200,000 and $3,400,000. The board considered this prudent until a new finance director calculated that average daily operating outflow was $82,000, so even 45 days of cover implied only $3,690,000 at the very top of the range and far less on a normal week.
She set a target cash balance of $1,900,000, based on 20 days of cover at $82,000 a day plus a $260,000 buffer for quarterly tax and insurance renewals. Balances above $2,300,000 were swept into 60-day deposits, and a $1,000,000 revolving facility was arranged as the safety valve rather than holding the cash outright.
Over the following year Rowan Park earned about $47,000 of additional deposit interest and never drew the facility. In this fictional case the improvement came not from more cash but from deciding, in advance, how much cash the business actually needed.
Watch out
Common mistakes.
- Setting a target once and never revisiting it, so a policy built for a $10,000,000 business is still in force when revenue has tripled.
- Confusing the target cash balance with the minimum balance; the target is a normal operating level, not the point at which the business runs out of options.
- Ignoring the timing of large irregular payments, so the balance looks healthy on average but falls short in the week the tax payment clears.
Questions
People also ask.
How many days of cover should a business hold?
It varies widely with predictability, but many stable businesses target somewhere between 30 and 60 days of operating outflow.
Does a committed borrowing facility reduce the target?
Yes, an undrawn facility acts as standby liquidity, so companies with reliable facilities generally run lower target balances.
What happens to cash above the target?
It is normally swept into deposit accounts, money market funds or used to repay revolving debt, depending on the treasury policy.
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