An emergency fund (sometimes referred to as 'retained earnings') is a liquid account which is only used in the event of unforeseen expenses or a steep drop-off in business. All too often, new business owners pour all of their resources into their operations. This includes not only time, but every last penny of money. A small business is voracious. Without an emergency fund, you won't have the resources to deal with problems as they occur because your margins are too thin to accommodate the unexpected.
To some, the idea of putting thousands of dollars into a savings account on the off chance that it may come in handy at some point in the future may seem impractical at best and unwise at worst. Yet if there is one guarantee in business, it's that events beyond your control will pop up impact on your cash flow.
Insurance may not cover every eventuality. Accumulating debt through lines of credit to cover problems and shortfalls is a prime reason that so many startups fail in their first few years.
Making provisions for emergency funds should be part of your business plan. As important as putting the money aside is knowing how, when and why to use it. Create a list of events that you consider sufficient reason to access your emergency funds, Such as:
Not every event has to be a disaster to warrant dipping into an emergency account. Liquid assets allow you to take advantage of unforeseen opportunities, too. If a competitor goes out of business, perhaps you'd like to buy their stock. Maybe a supplier has an overstock of an essential component of your product and you have to act quickly to buy up as much as possible at a discount. Emergency resources create a buffer that makes your business more adaptable and sturdy.
Just as your personal accounts are separate from your business accounts, your emergency funds account must remain separate from your regular expense account. This will reduce your impulse to dip into your savings for non-emergencies. The emergency fund should be considered off-limits except under certain circumstances.
Choose an account that you can easily access. This typically means a simple savings account. Accounts that are difficult to access or liquidate defeat the purpose.
It is tempting to place your emergency funds into a growth account such as a certificate of deposit. But liquidity is the goal, not interest. Avoid any account with fees, early withdrawal penalties or one that ebbs and flows with the stock market. Emergency funds must be rock solid and dependable.
The most common question asked about emergency funds is: "How much should I save?"
As a general rule, you should save enough money to cover all of your operating expenses for a minimum of three months. Calculate your monthly budget, including payroll, bills and property costs (don't forget to include your own salary), then figure your total goal.
As stated above, three months is the minimum buffer. The nature of your business may necessitate saving more than three months. Such factors as:
If any or all of the above apply, you may wish to save a year or more of operating expenses. As you can imagine, an emergency fund may become very large indeed.
Saving that much money out of your income may seem daunting.
As a small-business owner, you often have to put the needs of the business first. Assuming you're making money at all, you want to pay yourself. After all, what's the point of starting a business if you can't support yourself with the income?
Make no mistake, the money you hold back for an emergency fund will cut into the amount you take home. It does not, however, have to be a large amount. Most likely, you won't have the resources to save three to twelve months of operating expenses in one lump sum.
Think of the fund as another fixed expense like a utility. Once you know how much money you need to save, set a timetable for saving it. Then calculate the amount you must deposit every month to make your goal. Depending on your income, it may take several months to a couple of years to deposit the full amount.
A business that depends on ideal conditions to function is precarious and fragile. Your success depends on preparation. An emergency fund is insurance against everything that you can't foresee.