Short answer: Less than most advisors tell you. Keep enough to run the business and cover what you already owe, which is roughly three to six months of operating costs and owner pay plus the taxes and dividends you know are coming. Add months if your revenue is uneven. Cash above that is idle, and idle cash is not growing. Planned spending should come out of cash flow, not a stockpile. The reserve for surprises and opportunities can live in a contract you can borrow against, and you do not need access to 100% of what you put in for it to work. These are rules of thumb, not tax rules.
How do I size the working cash?
Two buckets. Add them up. Whatever sits above that total is the money you can think about putting to work for the long term.
| Bucket | What it covers | Illustration |
|---|---|---|
| Operating cash | Three to six months of operating costs and owner pay | $40,000 a month x 6 = $240,000 |
| Known obligations | Corporate tax, HST, declared dividends, personal tax on planned payouts | $60,000 |
| Total to keep as working cash | $300,000 |
Illustration: If the corporation holds $600,000, the amount to think about committing is $300,000. The figures are examples. Use your own.
Planned spending, such as equipment, a renovation or a hire, is not a third bucket here. If cash flow can fund it when the time comes, it does not need to be set aside today. If cash flow cannot cover it, include only the shortfall.
Why not keep a large cushion in cash?
Idle cash is just idle cash. It is not growing. It earns little, inflation eats at it, and the interest it does earn inside a corporation is taxed each year at a high rate (about 50% in Ontario, partly refundable when the corporation pays dividends). Meanwhile it is not doing a job.
A cushion that is bigger than the business needs is a choice to hold money in the place where it works the least. That is the reason to size the working cash tightly and decide deliberately what happens to the rest. See whether to invest inside your corporation or take the money out.
Can a contract act as the emergency fund?
Yes, and it is the reason the working cash can be smaller than the usual rule. Working cash is the business's defence. A contract can do that job and play offence at the same time. A participating whole life contract owned by the corporation has a cash value that grows, and the corporation can borrow against it. A loan on that cash value is how you meet a surprise or take an opportunity without selling anything or interrupting the growth. And it does more than one job. In the emergency nobody plans for, death, the contract becomes the emergency fund, because the death benefit is paid to the corporation.
You do not need to reach 100% of what you put in for it to work as a reserve. If you can reach, say, 80 to 90 percent of your contributions, that is a strong position for an emergency fund. How much you can reach, and how quickly, depends on how the contract is designed and the insurer. Ask for the cash value by year and compare it to the premiums paid, so you know what you could actually draw on in year one, year three and year five.
It is a lot like starting a new business. It takes a push at the start. Then each full premium adds more cash value than the year before, and in a well-designed contract it typically passes what you put in and keeps growing. How quickly depends on the design, and dividends are not guaranteed.
Two things to keep in mind:
- Loans carry interest. The cost is real. A policy loan above the policy's cost basis can create a taxable amount, so how you borrow is an interest-or-tax decision.
- Size the working cash to the gap. Keep enough working cash to cover the difference between what you could access and what you might need, then let the contract carry more of the reserve role as the cash value builds.
What happens if I commit too much too soon?
The cost shows up when you need the cash early. Each long-term option has its own version of it.
- A market investment may be down when you need it, so selling locks in a loss.
- Real estate can take months to sell, and selling costs are high.
- A whole life contract takes time to build. Surrendering very early can return less than you paid in, depending on the design.
- An individual pension plan is locked in until retirement.
None of these is a flaw. They are the price of what the structure does for you.
How long should long-term money stay committed?
My rule of thumb is five years or more for market investments and ten years or more for permanent insurance. If you may need most of the money back sooner than that, it belongs in the working cash.
What if my income is uneven?
Add months. A business with a few large clients, project work or seasonal swings can reasonably hold nine to twelve months of operating costs. The test is how long it would take you to recover if your largest source of revenue stopped.
Related questions people ask
Is six months enough?
For a stable business with diversified clients, three to six months is a common range. For a business with one or two dominant clients, long sales cycles or seasonal revenue, nine to twelve months is more common. Pick the number that matches how long it would take you to recover.
What should I do first if I have no cash reserve yet?
Build working cash before committing to anything long-term. Direct new profit to the corporation until it reaches your target. A long-term strategy funded from an empty account is how owners end up borrowing at the worst moment.
Should the cash sit in the corporation or personally?
It depends on what it covers. Business operating costs belong in the corporation. The personal portion of owner pay can sit in either place, but money in the corporation is not yours until you pay it out and pay tax on it.
Where can I read about the long-term options?
See what to do once your RRSP and TFSA are maxed and whether an incorporated owner should contribute to an RRSP.
Want to see how this applies to your corporation?
Book a call and we will look at your numbers together. If none of this fits, I will say so.
Book a call with Donny