How to Set Up an Emergency Fund for Your Small Business

The safety net you need for your small business operations

Advantages and Disadvantages of an Emergency Fund

A lack of available capital is a significant obstacle for businesses trying to survive in tough economic conditions or expand. In fact, 20% of small business owners say that a lack of available capital is their biggest challenge. In turbulent financial times, a lack of cash flow can mean a quick end for a small business, as only half of them have a cash reserve of just 27 days.

The widespread country closures in 2020 highlighted the urgent need for small businesses to have emergency funds in order to continue operations or survive during complete or partial lockdowns.

Emergency funds are simply liquid savings accounts that businesses can tap into when needed – reserves untouched by daily operations.

Certified Public Accountant (CPA) Kenneth Bucci told The Balance during a phone interview that many businesses use emergency funds when they see a drop in revenue due to a recession or economic crisis. However, he said they can also be crucial in maintaining business continuity in other circumstances, such as losing a key client, shifts in the industry, or even a lawsuit.

How to Determine the Size of Your Emergency Fund

Experts’ opinions vary on how much you should save as reserves, and it heavily depends on other factors affecting your business, as well as your operating costs.

When deciding on the amount to keep in reserve for emergencies, consider the following factors:

• Receivables and inventory
• Your business structure
• Your personal situation
• Seasonality

Based on these factors, you can identify the target amount you will need to handle your revenue and operating costs.

How to Utilize Your Emergency Fund

The first thing you need to decide is where to keep your emergency fund. For small businesses, Bucci said the best option for liquid savings is usually a business bank account. However, if you have $100,000 or more in your fund, Bucci suggested considering a money market account, which may yield slightly more interest than a regular account.

Bucci pointed out several critical moments when emergency funds can be utilized, including:

• A drop in revenue due to a recession or lack of interest in your product or industry
• Loss of a key client that makes up a large portion of your business
• Loss of a key employee that could lead to lost sales or require a significant amount of time and money to replace
• Inability of the owner or a key employee to work due to illness or other matters
• A legal issue – a rare but possible occurrence
• Any situation where your revenues don’t meet your expenses, and you cannot cover the difference through other means or by cutting operating expenses

Setting Up Your Emergency Fund

Before setting up your emergency fund, you might want to explore additional services offered by the bank or credit union you plan to use in the future, so it’s wise to find one you feel comfortable with and start building a relationship.

Once you find the right financial institution, open the account that suits your business. Whether it’s a savings account or a money market account, Bucci said it should take about just one day.

Starting to save regularly is the next step. According to Mah, you should deposit a specific amount in the account each month and pretend it doesn’t exist – just like you do with your emergency fund. Making it a priority will help you save more money in the long run.

Alternatives to an Emergency Fund

While emergency funds are essential for your business’s security, the reality is that some unexpected circumstances arise that are hard to prepare for – and larger than the money you have saved. If you find yourself in a situation where you don’t have enough emergency reserves, you can consider some other strategies.

• Line

Credit options: Maah said another option is to open a line of credit with your bank to give you a few extra months of flexibility over your emergency fund. You can also borrow a mortgage loan or a line of credit, or borrow against receivables or fixed assets, added Bucci.

• Contact the Small Business Administration (SBA): When you can’t obtain traditional financing – which is typically only possible if you have receivables or fixed assets to borrow against – the Small Business Administration can help you.
• Cut expenses: If you don’t have enough money to cover operating expenses, review each item and decide what can be trimmed to help lighten the load.
• Strategic partnerships with other businesses: Share real estate, employee groups, or other resources to reduce overhead costs and continue operations.
• Switch to contract workers or outsourcing: If you can’t meet payroll, consider outsourcing work or hiring freelancers or contractors. This may provide a lower-cost alternative to help you get through a downturn.

Source: https://www.thebalancemoney.com/how-to-set-up-an-emergency-fund-for-your-small-business-5072906