Cash is the lifeblood of a business, and holding cash reserves gives small business owners confidence to grab opportunities and take risks. It covers overheads in a slow business environment without taking a loan. It also lets you seize opportunities, such as supplier discounts for upfront payments, or absorb a sudden surge in raw material costs. The generic six-month expenses cash cushion doesn’t always work, as the cash reserve depends on the industry, the business’s growth phase, and its capital structure. Sometimes, debtors might require a company to hold a certain amount of cash as a debt covenant.

While cash gives you the flexibility to pay salaries, utilities, inventory, and fund growth, too much of it can harm your business. It could reduce your purchasing power, generate taxable passive income, and trigger high tax liabilities by making you ineligible for tax benefits.

The question isn’t whether your corporation should hold cash, but how much.

Cost of Having Too Much Cash Reserve

While cash gives small business owners peace of mind, it also comes with different risks. All business owners know the consequences of having insufficient cash reserves. But that doesn’t mean you should keep ample cash idle on the balance sheet. Businesses aren’t money vaults hoarding cash; they are tools that make money work.

Cost of Inflation

Most businesses hold cash reserves through money in bank accounts, money market instruments, and term deposits that are easy to liquidate. Holding too much cash in a low-interest account won’t outpace inflation over the long term, eroding the purchasing power of your reserves. Your business needs liquidity, but it should serve a purpose. Every reserve should have an objective, such as buying equipment, paying salaries, or bearing rising raw material costs.

Cost of Small Business Deduction

The Canada Revenue Agency (CRA) offers the Small Business Deduction (SBD) to Canadian-controlled private corporations. Incorporated businesses pay a reduced federal tax rate of 9% (instead of 15%) on the first $500,000 of active business income earned by the business together with associated corporations. The SBD phases out if the business and its associated corporations’ combined investment income is between $50,000 and $150,000. Losing this deduction could create a significant tax liability for a profitable business.

Hence, small business owners should plan their investment strategy with the company’s tax position, cash flow needs, and long-term plan in mind.

Cost of Lifetime Capital Gains Exemption

The CRA offers a lifetime capital gains exemption (LCGE) to Qualified Small Business Corporation (QSBC) shares and Qualified Farm or Fishing Property (QFFP). Under the LCGE, QSBC owners can sell their business shares and be exempt from capital gains tax. This exemption is $1,275,000 for 2026 and increases with inflation. This means that if you sold your shares in the business for a $1.5 billion capital gain, only $750,000 (50% of the gain) would be taxable. If you qualify for LCGE, this taxable gain is exempt.

To qualify for LCGE, your shares must meet three criteria:

• At the time of the sale, at least 90% of the business assets must be actively used in a business carried on primarily in Canada.
• The taxpayer should own the shares for at least 24 months immediately before the disposition.
• During these 24 months, more than 50% of the corporation’s assets must be actively used in a business carried on primarily in Canada.

If you hold too much cash, the business may fail to meet the 90% and 50% active assets criteria. And if you sell your business, you might end up footing a heavy capital gains tax bill.

Thankfully, you can “purify” the corporation and make it eligible for LCGE. However, removing excess cash reserves in a tax-efficient way requires proper planning. A professional tax consultant is well-versed in navigating CRA laws and executing such transactions in compliance.

So far, we have seen how idle cash reserves can cost the corporation dearly through lost tax benefits and reduced purchasing power. So how do you determine the right amount of active cash reserves?

How CRA Determines Cash Reserve as Active Asset

The CRA has provided general guidance on which cash reserves constitute an active asset. The general rule is that cash on hand must have a purpose to be considered an Active Asset.

• The amount of cash needed to keep the business stable is considered an active asset.
• A temporary surge in cash reserves that can be justified with business needs may be considered actively used in the business. For instance, a company may increase cash reserves to fulfill a big order.
• If a business accumulates cash reserves that fluctuate seasonally, it could be considered an active asset. For instance, a retailer’s cash balance surges after the Black Friday sale and depletes over the next six months.
• The cash balance a corporation must maintain to do business is also an active asset. A supplier or lender may require a business to maintain certain cash, and that will be considered actively used.

Cash accumulated to buy a capital asset, like equipment or land, or to repay long-term debt is not considered active. So if you have been accumulating cash but don’t use it for growth or debt reduction, it will count as passive assets and eat up the SBD and LCGE tax benefits.

What To Do with Surplus Cash Reserve?

The corporate cash surplus could mean different things for different business owners. Some might retain earnings in cash reserves for expansion, acquisition, technology, or asset purchases. Some might be accumulating cash in corporate accounts as part of their retirement plan. Because the corporate tax rate is lower than the individual tax rate, business owners have more money to invest.

Clearly define your financial goal and timeline. If you won’t need the money for the next three to five years, consider investing it in long-term assets like stocks and mutual funds through a corporate investment account.

If your goal for the corporate reserves is retirement, you could use them to fund a retirement plan involving corporate-owned insurance, an Individual Pension Plan, structured drawdown, and other estate planning tools.

Business owners can hold cash in the corporation, but they need to plan it considering liquidity requirements, tax efficiency, investment strategy, retirement planning, and estate goals. Managing adequate cash reserves requires budgeting, forecasting, tracking cash flows, and planning for short-term needs and long-term investments.

Contact Ford Keast LLP in London to Help You Manage Cash Reserves

Talk to a professional accountant and tax advisor to help you manage and assess financial statements, prepare budgets, and forecast cash needs to support business objectives, ensuring cash is used effectively in the business. To learn more about how Ford Keast LLP can provide you with the best accounting and taxation services, contact us online or call us at 519-679-9330.