Petty cash management explained

In the world of business finance, petty cash might seem like a small change, but it can make a big difference in your day-to-day operations. This often-overlooked financial tool is the unsung hero of smooth-running businesses everywhere.

But what exactly is it, and why should you care? 

Let's dive into its world and discover how this financial resource can become your small business's secret weapon for efficiency and flexibility.

What is petty cash?

Petty cash is a small amount of money kept on hand by a business to cover minor, day-to-day expenses.

It's the financial equivalent of the loose change in your pocket – readily available for those small, unexpected costs that pop up in daily operations.

But don't let its name fool you; it’s anything but trivial when it comes to keeping your business running smoothly.

The concept dates back centuries, with records showing its use in ancient civilizations for managing small transactions. 

In modern business practices, it has evolved into a structured system for handling minor expenses efficiently. It's typically managed through a petty cash fund, a fixed amount of money set aside for these small purchases.

Understanding what is petty cash is crucial for businesses of all sizes.

It's not just about having a few dollars on hand; it's about creating a system that balances convenience with accountability. 

It can streamline your financial processes and save valuable time and resources when managed correctly.

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Struggling with money? Check out 5 tips for securing the capital you need to scale your business.

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What is petty cash used for?

The uses are diverse and can vary depending on the nature and size of your business. Here are some common scenarios where it proves invaluable:

1. Office supplies: Running out of printer paper or needing a new stapler? It can cover these small but essential office needs without needing a formal purchase order.
2. Postage and shipping: When you need to send out a quick package or letter, petty cash can cover the cost without delay.
3. Employee reimbursements: If an employee picks up coffee for a meeting or pays for parking while on a business errand, those coins can be used for prompt reimbursement.
4. Minor repairs: A loose doorknob or a flickering light might require immediate attention. Your “small money” fund allows for quick resolution of these small maintenance issues.
5. Local transportation: Taxi fares or public transport costs for short business trips can be easily paid with those bills in your office drawer.
6. Refreshments for meetings: When you need to grab some snacks or drinks for an impromptu meeting, petty cash comes to the rescue.

By using PC for these types of expenses, businesses can avoid the administrative burden of processing numerous small transactions through their main accounting system. 

This not only saves time but also reduces processing costs associated with cutting checks or using company credit cards for minor purchases.

There are other ways to keep your accounts in the green: Deferred payment: the secret of efficient cashflow.

Pros and cons of petty cash for SMBs

For small and medium-sized businesses (SMBs), deciding whether to implement a petty cash system requires careful consideration. 

While it can offer significant advantages, it also comes with potential drawbacks. 

Let's explore both sides of the coin to help you make an informed decision for your business.

✔️ Pros

1. Convenience and flexibility

A cash fund provides immediate access to funds for small, unexpected expenses.

This flexibility can be crucial for SMBs that need to make quick purchases or handle minor emergencies without delay.

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2. Time and cost savings

Processing small transactions through a company's main accounting system can be time-consuming and costly.

A small cash reserve eliminates the need for formal purchase orders or check writing for minor expenses, saving valuable time and reducing administrative costs.

3. Improved cashflow management

By allocating a fixed amount to a sundry fund, businesses can better control and predict small-expense spending.

This can aid in more accurate budgeting and cashflow forecasting, which is crucial for SMBs operating with tight margins.

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Don’t get confused with economic jargon. Read: The great debate: cashflow vs revenue and their importance.

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4. Employee empowerment

A well-managed system can empower employees to make necessary small purchases without constantly seeking approval.

This can boost productivity and morale by demonstrating trust in your team's judgment.

5. Simplified record-keeping for small expenses

While all expenses need to be recorded, it allows for a simplified system of tracking small costs.

Instead of processing numerous small transactions individually, businesses can record petty cash replenishments as a single entry, streamlining bookkeeping.

❌ Cons

1. Security risks

Keeping cash on hand always carries a risk of theft or misuse.

For SMBs with limited security measures, this risk can be particularly concerning.

2. Potential for misuse or abuse

Without strict controls, employees might be tempted to use that cash on hand for personal expenses or fabricate receipts.

Even if not intentional, lax oversight can lead to a culture of careless spending.

3. Administrative burden

While petty cash can reduce some administrative tasks, it also creates new ones.

Regular reconciliation, fund replenishment, and maintaining accurate records require time and attention.

For very small businesses, this additional task might outweigh the benefits.

4. Limited expense tracking

Cash transactions can be more challenging to categorize and analyze compared to electronic payments.

This can make it harder to gain detailed insights into spending patterns or to identify areas for cost-cutting.

5. Cash handling errors

Human error in counting cash, recording transactions, or filing receipts can lead to discrepancies in accounts.

These errors can be time-consuming to track down and correct.

6. Regulatory compliance challenges

Depending on your industry and location, maintaining a petty cash fund might complicate regulatory compliance.

Some industries require detailed records of all cash transactions, which can be more challenging with a miscellaneous fund system.

7. Scalability issues

As a business grows, managing petty cash across multiple locations or departments can become increasingly complex.

What works for a small office might not be suitable for a rapidly expanding enterprise.

How much petty cash should a business have?

Determining the right amount of petty cash for your business is crucial for maintaining efficiency without exposing yourself to unnecessary risk.

Consider the following factors:

• Business size and type: A small retail shop might need less than a medium-sized consulting firm with frequent client meetings.
• Frequency of small expenses: If your business often incurs minor costs, you might need a larger fund.
• Cashflow: Ensure your fund doesn't tie up too much of your working capital.
• Security concerns: Keeping large amounts of cash on hand can be a security risk.
• Replenishment frequency: If you're willing to replenish more often, you can maintain a smaller fund.

As a general rule of thumb, many small businesses find that a petty cash fund of $100 to $500 is sufficient. 

However, this can vary widely based on individual circumstances. It's a good practice to start with a conservative amount and adjust based on actual usage over time.

Petty cash example: a day in the life of small business finances

To better understand how PC works in practice, let's walk through a typical day at a small marketing agency:

• 9:00 AM: Sarah, the office manager and petty cash custodian, starts the day with $300 in the piggy bank.
• 10:30 AM: Tom, a graphic designer, needs to purchase a specialized font for a client project. He requests $50 from the fund. Sarah records this on a voucher and gives Tom the money.
• 12:15 PM: The team decides to order lunch for an important client meeting. Emily, the account manager, uses $75 from the fund to pay for the delivery. She brings back the receipt to Sarah.
• 2:30 PM: The office printer runs out of toner. Sarah uses $60 from the PC to purchase a replacement cartridge from a nearby office supply store.
• 4:45 PM: At the end of the day, Sarah counts the remaining cash ($115) and tallies the vouchers and receipts ($185). The total matches the original $300 fund amount.

This example illustrates how a small fund can facilitate quick, necessary purchases throughout the day without disrupting workflow or requiring complex approval processes.

Petty cash accounting: keeping your books balanced

Proper accounting is crucial for maintaining accurate financial records and ensuring transparency in your business operations. Here's how to handle petty cash accounting effectively:

1. Initial setup: When you first establish your fund, record it as a debit to the ‘Petty Cash’ account and a credit to ‘Cash’.
2. Expense recording: As petty cash is used, collect receipts and vouchers. When it's time to replenish the fund, categorize these expenses in your accounting system.
3. Replenishment: When replenishing the fund, debit the appropriate expense accounts based on the receipts and credit ‘Cash’ for the total amount.
4. Reconciliation: Regularly count the remaining cash and compare it to the balance of receipts and vouchers. The total should equal your original fund amount.
5. Adjustments: If there are discrepancies, investigate the cause. Small differences can be recorded as a miscellaneous expense or over/short account.
6. Financial statements: The petty cash account should appear as a current asset on your balance sheet, typically under the ‘Cash’ category.

‍🚨 It's important to note that while petty cash transactions may seem minor, they still need to be accounted for accurately. The IRS and other tax authorities require businesses to keep records of all expenses, regardless of size. Proper petty cash accounting ensures you're prepared for audits and have a clear picture of your business's financial health.

8 practical tips to maximize petty cash management

Want to make the most of your coins?

Follow our tips:

1. Use technology: Consider using digital tools or apps designed for petty cash management. These can help automate record-keeping and reduce errors.
2. Regular audits: Conduct surprise audits of the petty cash fund to ensure accuracy and deter misuse.
3. Rotate custodians: If possible, periodically rotate the responsibility of managing petty cash among trusted employees to reduce the risk of fraud.
4. Set clear limits: Establish and communicate clear limits on individual transaction amounts and types of allowable expenses.
5. Train employees: Ensure all staff members understand the petty cash policies and procedures.
6. Review and adjust: Regularly review your petty cash needs and adjust the fund amount or policies as necessary.
7. Consider alternatives: For some expenses, corporate credit cards or digital payment methods might be more efficient than cash.
8. Document everything: Maintain detailed records of all petty cash transactions, including dates, amounts, purposes, and recipients.

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This might come in handy: 7 reasons why every business owner should embrace cashflow forecasting

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Is it even worth the trouble?

Petty cash, when managed effectively, can be a powerful tool in your business's financial arsenal. It provides the flexibility to handle small, day-to-day expenses efficiently, freeing up time and resources for more strategic financial management.

By implementing a well-structured system, you can streamline operations, improve cashflow management, and maintain better control over minor expenditures.

Remember, the key to success with PC lies in striking the right balance between convenience and control. 

With clear policies, diligent record-keeping, and regular reviews, your petty cash fund can truly become your small business's secret weapon for financial agility.

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