We may be moving towards a cashless economy, but there are still plenty of times when having a little bit of cash on hand at your small business is easier than cutting a check.
Maybe the printer just ran out of paper, or you want to make a Starbucks run to get everyone fired up for a big day. That is when setting up a petty cash fund at your small business makes sense.
What is petty cash?
Petty cash, as the name implies, is a small fund of cash kept on hand for small purchases. The amount of the fund depends on the size of the company and number of employees, but it is most typically a few hundred dollars.
Petty cash is generally used for small expenses, such as postage, bagels, or sandwiches for the office, birthday cards, flowers, and office supplies.
Why should I use petty cash?
In the early days of a business, owners typically pay for all these things with the cash in their wallets, or maybe by borrowing a few dollars from the cash register. But casual approaches like those make it tough to keep track of those expenses. Allowing employees to borrow from the till rarely ends well.
While each expense may be insignificant on its own, they can add up to big numbers. Losing those deductions means you are overpaying your taxes, plus you lose visibility into the true costs of running your business.
While the IRS won’t mind if you pay more than you need to, most business owners would rather keep their hard-earned cash for themselves.
Making employees submit an expense report before they can be reimbursed for small business-related expenses may put them in an awkward financial bind. Plus, handling everything through expense reports just creates more paperwork to manage.
That is why setting up a formal system for managing your petty cash is a smart choice.
How to manage petty cash
Setting up a formal process for managing a petty cash fund protects your business from theft, and helps to capture every expense.
Here are the best practices for setting up and managing a petty cash fund.
1. Choose a custodian.
This may be the most important decision you make. The custodian should be someone who is generally available during business hours, and who sits in a place readily accessible to everyone in the business, possibly near the front of the office.
Choose someone who has a reputation for honesty, integrity, and trustworthiness, and who is loyal to the company. Don’t choose someone who has obvious financial pressures because that can easily lead to theft.
The custodian will be responsible for disbursing the funds, keeping records of how the money was spent, and requesting replenishment when the fund is depleted. They need to fully understand what expenses are appropriate, and which are not so that only business-related expenses are paid out of petty cash.
2. Establish policies for using petty cash funds.
You and your team will need to decide what kinds of expenses can be paid with the petty cash fund. This makes it clear that the funds are to be used for business-related expenses, not personal purchases.
Most businesses use petty cash to buy small things like office supplies, postage, coffee, and snacks, or parking. Paying for a pizza so that everyone can keep working is OK, but buying yourself lunch every day is not.
Your petty cash policy should include the total amount of the fund, also called the “float,” and the maximum amount of a petty cash transaction, perhaps $25 or $50. You’ll also need to set up procedures for disbursing, replenishing, and protecting the cash.
These policies should be set in writing and shared with everyone at the company.
3. Add petty cash to your chart of accounts.
Putting petty cash on your books helps with tracking expenses, and makes it much easier when it comes time to replenish and reconcile the account.
4. Fund the petty cash account.
To fund the account, cash a check or make an ATM withdrawal for the maximum amount of the float. The float should be enough to cover cash expenses for at least a week or a month so that it doesn’t need to be replenished more often than that.
Depending on the size of the organization, $50 might be plenty, or you may need $500 or more.
5. Keep the funds locked up.
A lockbox or a locking desk drawer should be used to limit access. Only the custodian, the controller or CFO, and possibly the owner of the business should have the key or the combination for the lock. The lockbox should be kept out of easy reach of customers and employees.
6. Reimburse expenses.
When an employee gives the custodian proof of eligible purchase, the custodian reimburses them with cash.
In some organizations, employees are allowed to take an advance from petty cash, leaving behind a signed IOU. After the purchase is made, the employee exchanges the IOU for the receipt and any change.
Requiring a receipt for every purchase is a best practice. Even though the amounts may be small, keeping documentation of the uses of petty cash keeps everyone honest.
7. Record the disbursements.
Keeping a record of transactions keeps everyone accountable, and helps to ensure that the funds are being used appropriately. Some companies use paper vouchers, while others keep a log, either in spreadsheet or paper form.
In either case, the custodian should record the date of the disbursement, the name of the employee, the amount of the purchase, where the purchase was made, and what was bought.
8. Replenish the fund as needed.
When funds run low, the custodian should exchange the receipts and vouchers for enough cash to bring the fund back to the float.
You replenish the fund by cashing a check for the difference between the balance of cash in the lockbox and the float. If the fund needs to be replenished more than once a week, consider increasing the amount of the float.
9. Record the transactions in your accounting system.
As an internal control, the person recording the transactions should not be the custodian. Here is a journal entry to record expenses when the petty cash fund is replenished:
Memo: To record transactions paid with petty cash
10. Reconcile petty cash regularly.
At least monthly, the balance of cash in the fund should be reconciled against the expenses paid. Weekly reconciliations may be needed when there is a heavy volume of transactions.
Depending on your organization’s tolerance for errors, small discrepancies might not be worth pursuing, but any large variances should be investigated. Maybe someone forgot to bring back a receipt, or maybe the custodian made a mistake in disbursing funds or recording a transaction.
Until we move to a completely cash-free economy, having that little bit of cash on hand in a petty cash fund can help keep your business running smoothly. It provides a simple mechanism to pay for small expenses.
Managing your petty cash allows you to capture all of your business expenses, which can add up to significant tax savings in addition to providing visibility into all the costs of running your business.
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I am Adeyemi Adetilewa, a media consultant, entrepreneur, husband, and father. Founder and Editor-In-Chief of Ideas Plus Business Magazine, online business resources for entrepreneurs. I help brands share unique and impactful stories through the use of public relations, advertising, and online marketing. My work has been featured on the Huffington Post, Thrive Global, Addicted2Success, Hackernoon, The Good Men Project, and other publications.