Most people understand the importance of keeping an emergency fund in their personal life. Do you realize just how important it is for your business to have one too?
No one is immune to the rain; hard times affect business owners like everyone else.
To understand why your business needs an emergency fund, we'll discuss what this fund entails, how to take steps toward creating an emergency fund that will protect your company's financial health, and how this will benefit you in the long run.
Let's get started.
Why Your Business Needs an Emergency Fund
Putting together an emergency fund for your business will help your company thrive in more ways than one. Here are three key reasons why now is the time to start building your company's emergency fund.
1. Immediate Access to Cash During Emergencies
As the name implies, an emergency fund will allow your company to react with more agility when emergencies arise.
There's no predicting the future.
Your company could be impacted by a natural disaster, another pandemic, or supply chain issues that are impossible to overcome.
When situations like these arise, they're much easier to deal with when you have cash on hand. You'll be able to get through a few challenging months without having to seek out a predatory loan.
Having an emergency fund puts your business in a much better place to succeed post-emergency than where you'd be without one.
2. Avoid Cash Flow Issues
As a business owner, you know there are times when cash-on-hand gets lower than you'd like. In some cases, you can skate by without problems. But when cash flow becomes a problem for a prolonged period, it can create issues with suppliers, employees, and products.
The average amount of cash on hand for a small business is about two months. But if you have an emergency fund that you can tap into when necessary, you'll have a much longer runway when cash is low.
That way, your business can continue its operations unimpacted by the cash flow issues, and you won't have to stress as much about momentary dips in cash on hand.
3. Take Advantage of Unexpected Opportunities
A significant aspect of growing a business is taking advantage of the best opportunities when they present themselves. The only problem is that opportunities arise without warning; you never know when something may come up that could take your business to the next level.
When you have an emergency fund, it won't matter.
You'll have the cash that you need to take advantage of unexpected opportunities no matter when they happen.
An emergency fund can make it easier for you to advance your business, guaranteeing that you never have to say no to a big chance just because you don't have enough cash.
How Large Should Your Emergency Fund Be?
Now that we've covered why having an emergency fund is vital for your business, it's time to begin creating your plans to put one together. The first step in that process is figuring out just how much savings you should keep.
A business should generally have an emergency fund large enough to cover at least three months of expenses.
So if your company loses all its income tomorrow, you could keep operating as usual for at least three months.
However, even that may not be enough for some companies. Some sectors are incredibly volatile. If you operate in an industry like luxury goods or travel, you may want to save 6-12 months of expenses in an emergency fund to account for prolonged downturns in business.
The requirements of your emergency fund largely depend on your company and industry. Think of 3 months as a minimum and 12 months as a maximum, then go from there.
How to Begin Saving an Emergency Fund
It's much easier to say that your business should have 3-12 months of operating expenses saved in an emergency fund than to get this done. So, here are some tips to get you started.
Open a Separate Banking Account
First, keeping your emergency fund in the same account as your regular business checking is not a good idea. Maintaining separation between the two will make it easier to avoid using your emergency fund except in the specific scenarios you've outlined.
A High Yield Savings Account (HYSA) is an excellent location for your emergency fund.
Some businesses keep their emergency savings in brokerage or money market accounts to make their money work for them.
Some use a Certificate of Deposit (CD) account, but CDs carry earlier withdrawal penalties, even though you can earn interest by utilizing one. These accounts limit your ability to withdraw funds, which is the antithesis of what you want from an emergency account.
The easiest thing to do is open up a savings account attached to your business checking account. That'll make it easy to transfer money into your emergency fund and withdraw it quickly when necessary.
Look to Cut Expenses
Your business needs to be financially stable to create an emergency fund. In that case, it may be time to look into cutting your expenses – at least until you've managed to save up enough to create an emergency account.
Working with a bookkeeper to identify areas to cut makes reducing your overhead much more straightforward.
Your office can survive without updated decor temporarily. Or, reduce your marketing budget until you've reached your savings goals.
You may need to get creative to find the cash you need to establish an emergency fund. But it'll always be worth it to take the time to do this – especially since it'll only be a temporary change until you can reach your goals.
Take Your Time
Most companies won't be able to create their ideal emergency funds through a single lump-sum deposit. But you can reach your savings goals over time.
The most important thing is just to get started.
Create the account where your emergency fund will be if that's all that you can do for now. Over time, you'll gradually add to it, and eventually, you'll reach your goals.
It can also be helpful to do some forecasting at the beginning of your savings journey.
Calculating a reasonable monthly savings amount will help you better understand how long it will take to achieve your goals.