Running a business takes a lot of work. As a small business owner, the goal is for the hard work to pay off and translate into revenue, customer acquisition and growth. Revenue can help facilitate your business’s operations, whether it’s paying salaries, purchasing equipment and supplies, paying rent and utilities, taking advantage of unexpected opportunities or investing money back into the business. Business owners learn quickly to manage their money, balance the books and make sure that the business is healthy and meeting all of its obligations.
But no matter how well a business is managed, sometimes an emergency may arise and owners may find themselves in need of financial assistance. For many, this assistance may come in the form of a business loan or line of credit. However, these loans and lines of credit come with risks, including high interest rates and late fee penalties. There’s also no guarantee that a business can secure these loans, and even if they do, it can take weeks to complete the application process and receive the needed funds.
But there is another more reliable option — establishing a small business emergency fund that can help you get through a tough time or meet a need for a cash infusion.
How Much Should a Business Save for an Emergency Fund?
An emergency fund is money set aside by a business owner to access just in case there is a sudden unexpected financial need. Think of it as a safety net. Business owners learn quickly that no matter how well a business is managed, not everything runs smoothly. And most of the time, the problems can come from unexpected places like supply chain issues, broken or damaged equipment or even from natural events such as floods, fires or power outages.
Although business insurance can help cover some of these unforeseen events, it will not help if an employee unexpectedly quits or if there is a vendor or supply issue. And even with insurance, there may be deductibles as well as a delay in receiving the required funds.
Most of us know from our personal finances that it’s a good idea to have three to six months of saving to meet an unexpected event such as a job loss, illness or major home repair. The same applies to businesses. Granted, saving money is no easy task and will require a steady and consistent plan of setting dollars aside on either a weekly or monthly basis. This diversion of funds into a liquid savings may appear counterintuitive to people who like to put their money into high-return investments, but having your small business emergency fund in the stock market may not be the best idea due to risks and market fluctuations.
Rather, an emergency fund should be in an easy-to-access, 100 percent liquid, high-yield business savings account. Though your money may not grow much due to the current low interest rates, there is also no risk of losing your investment like you would if there was a steep decline in the stock market.
The Benefits of Having a Small Business Emergency Fund
An emergency fund is set up to keep a business going no matter what the issue is. Liquid funds in a business savings account can be quickly accessed and provide the cushion needed for a business owner to get back to work. On average, it’s recommended that businesses have a reserve of three to six months to meet any unexpected expense.
Having the right financial planning, including cash in reserve, can also help a business owner take advantage of an opportunity such as buying discounted inventory or ramping up production should there be an unexpected rise in customer demand. Other benefits of having a small business emergency fund include:
Avoid high-interest loans. Applying for a business loan or line of credit can take time and there is a real risk of getting rejected. And even if a loan is approved, it may take time to get the money. Paying off the loan also comes at a cost with high interest rates and penalty fees if payment is late.
The fund can support your business until the “emergency” is resolved. It doesn’t take much to imagine this scenario. Think back to the start of the pandemic when businesses saw a major slowdown, through no fault of their own. Although government programs and loans helped some businesses stay afloat, it wasn’t enough to save many small companies. The coronavirus pandemic saw over 100,000 businesses permanently close and many others work at greatly reduced capacity. For many, an emergency fund could have kept them going until government loans and aid programs kicked in.
Peace of mind. There is so much a small business owner can worry about when it comes to running their company, let alone what’s beyond their control. An emergency fund is like an insurance plan but better. It provides immediate access to help tackle an immediate need.
5 Tips on How to Save for an Emergency Fund
The process of setting money aside requires commitment. It’s saving money for a rainy day that you hope will never arrive. Still, saving is not the easiest thing to do, especially when there are other obligations, needs and maybe even wants that these funds can go towards. So to make things a little easier, here are a few tips to help you not only get started but to also stay consistent with your savings plans.
Put aside a small about each week or each month for the fund because no matter how small, it'll eventually add up to larger balances. For example, $100 a week would grow to $5,200 in a year. If you save the same amount for seven years, the fund would grow to $36,400 without even counting any interest earned.
Set up automated deposits into your business savings account.
If business is going well, increase the amount you set aside proportionally.
Revaluate your emergency fund savings plan every 12 months.
Using an Emergency Fund Calculator
In terms of calculating how much money to set aside for an emergency, the rule of thumb mentioned above is to have three to six months saved. To help fine-tune this calculation, there are a number of free emergency calculators online to help determine how much you’ll need to set aside each month.
Many banks and financial institutions offer free emergency fund calculators online. Here are just a few options.
An emergency calculator will look at your revenue as well as your expenses, including rent, utilities, healthcare costs, debt, etc. Using a calculator is a good start in figuring out how much money you’ll need to operate or make up for a loss in revenue.
Having a Plan B
Running a small business takes a lot of hard work. There are dozens of variables that will play into the success or failure of your business. Having the foresight to accept that emergencies happen regardless of how careful you are will give you the opportunity to plan and prepare. An additional step to help cushion an emergency event is working with a financial consultant and exploring other safety valves and options, including having the right types of insurance and added coverage.
Unfortunately, emergencies are not uncommon. They happen, and for some more often than others. And they always happen in the most unexpected and inopportune times. To ensure that your business survives any surprise event, it is important to have a plan in place and the money to implement that plan. The question should never be whether or not an emergency will happen, but rather when.
Peter Mavrikis is an author and editor with over 25 years of experience in publishing. He has worked as the Editorial Director for Barron’s Educational Series, as well as Kaplan Test Prep, where he ran the test prep, foreign language, and study guide divisions. Peter has also written several books on history, exploration, science, and technology.