No one can foresee what the future holds for any business but having business emergency funds available can help with keeping afloat during difficult times. Let’s dive into business emergency funds: what they are, how to calculate how much to save, how to set up an account, and strategies that may streamline the whole process.
What Are Business Emergency Funds?
An account earmarked for business emergency funds provides you with a nest egg to use for emergencies and new opportunities that fall on your business doorstep.
Also called cash reserves, capital reserves, retained earnings, or corporate emergency funds, this money comprises a financial safety net for your business. They can be cash in a bank account, funds in a money market account, or liquid assets that can be quickly converted to cash in an emergency.
Business emergency funds should not come from credit cards, high-interest loans, unsecured loans, or personal retirement accounts. Similarly, business owners should not use their personal savings accounts to keep their businesses afloat during emergencies. This is especially true if tapping a business emergency account is an option.
Emergency funds can help keep a business from closing its doors during financial distress, a natural disaster, or a major illness within the company.
Dipping into this reserve may allow owners to pay company bills such as utilities and supplies costs and keep payroll current. This keeps your business running so you can continue offering your customers goods and services.
Why Do You Need Business Emergency Funds?
Not every business day can run smoothly—especially when the unexpected happens. Some businesses regularly face seasonal peaks and valleys or occasional slowdowns.
Without a cash reserve during slow times, it might be difficult to generate proper operating expenses. You want a comfortable income to meet company obligations and innovate or expand. Emergency funds may provide the financial safety net every business needs.
For example, no one anticipated the Covid-19 pandemic or how it brought the global economy to its knees. Most business owners will probably never experience a business disruption as serious as that again in their lifetimes. Regardless, they may experience smaller events that can have a negative impact on a company’s cash flow.
What happens if a big-account customer is late paying or several smaller customers are late? Perhaps a vital piece of equipment broke down and needs to be replaced. A key employee resigns, or you, the owner, suffer an illness that keeps you from the workplace for several weeks.
If you operate your business from one payroll cycle to another, you may be hard-pressed to pay for that new equipment or keep bills current during an emergency. Having emergency funds set aside may help provide uninterrupted cash flow for your business.
Unfortunately, many small businesses often run up against financial emergencies inadequately prepared. Having business funds earmarked specifically for emergencies can help keep business owners from using their savings or incurring more debt to keep the lights on and doors open.
Benefits of Building Your Emergency Finances
No one can predict when an emergency will strike—but you can plan for how to handle one when it does occur.
Setting aside a portion of your profits as a business emergency fund is perhaps one of the best investments one can make. But the benefits extend beyond immediate cash access—let’s look at what else a ready emergency fund can offer your business.
Security and Peace of Mind
Business emergency funds can help keep you from worrying about your business cash flow. This money can act as an insurance policy without dipping into your personal savings, providing your business more financial stability.
The Ability to Pay Bills
When an economic downturn or surprise strikes, an emergency fund may help you keep paying your business bills, ordering supplies and stock, and issuing payroll checks. During a natural disaster, it can provide money to repair and rebuild while waiting for insurance company payouts.
Funding New Opportunities
Having available cash may also help you take advantage of new, unexpected business opportunities. You can expand, launch a new product line, buy new equipment, acquire extra inventory during special sales, and innovate.
Business emergency funds may provide the money to bankroll those new opportunities—especially if the emergency account has extra funds.
How Much Should I Save Up?
The amount you set aside as business emergency funds, of course, depends on the specifics of your business.
Cash Flow
First, consider your monthly cash flow statement and other financial papers to determine your monthly expenses. Those statements show how much working capital may be needed to pay business obligations, such as:
- Utilities
- Payroll
- Inventory purchases
- Materials/goods purchases
- Office supplies
- Insurance
- Healthcare
In addition, if you carry inventory for sale, you likely need a larger emergency fund.
Structure
Next, consider the business structure. How much business is dependent on employees?
Is it a sole proprietorship with no employees? Is your business dependent on sales of services or products? Do you carry a lot of inventory? What kind of technology do you use? How do you advertise?
Analyzing your business structure can give you a deeper understanding of how losing revenue because of an emergency might impact your company's day-to-day operation. It may also reveal who might be affected by your business doors being shut: employees, customers, suppliers, and other vendors.
Does your company face seasonal peaks and valleys in production or sales? Do you have more customers in the summer or when schools are in session? Is your revenue determined by referrals or steady advertising? Any fluctuations can affect the amount you put into a business emergency account.
Future Considerations
Determining how much you will need for business emergency funds also means casting an eye farther afield—beyond just the next year. Your day-to-day business expenses may cost more in the future than they do now. Consider building in a cushion to cover increased costs.
Business Growth
In addition, consider business growth. Will you need to hire new employees, expand your storefront, add new equipment, or open a satellite office? Do you want to innovate or offer new products or services? If so, you might need more cash reserves for those future expenses.
How Big of an Emergency Fund Do You Need?
Generally, many business experts suggest putting three to six months of business expenses into your emergency account. However, after the impact of the Covid-19 pandemic on the economy, some advisors suggest setting aside eight months of expenses—or even up to a year’s worth.
You can determine your monthly expenses either by studying your monthly financial reports over several months or looking at last year’s expenses that you calculated for taxes.
Divide that yearly amount by 12 to determine your monthly expense needs, and then multiply that by how many months you want your fund to cover.
Assess what sources of cash are available to you as a business owner. Remember that ideally, business emergency funds should be easily accessible—liquidity is vital in an emergency.
Determine what assets you could sell quickly; longer-term investments are perhaps better off staying where they are since those funds are harder to liquidate and often carry a financial penalty for early withdrawal.
Building Up Your Small Business Emergency Fund
Remember that as your emergency account grows, you might want to place some of those funds into a money market account or other accounts where you can take advantage of a larger return. These funds, however, may not be as liquid as a standard savings account payments.
Deposit funds regularly and start small if you must. One way to ensure you don’t forget to stock your emergency funds is by automating regular payments from your business account.
Consider setting a monthly or weekly savings goal, depositing a percentage of your daily, weekly, or monthly revenue as a regular fixed business expense. Likewise, you might try saving more when business is doing well to retain enough funds to continue operations without a snag during slowdowns.
Create guidelines for when you can tap those emergency funds—you may use them for illnesses, natural disasters, equipment breakdowns, business downturns, or slowdowns. Evaluate your savings plan yearly and adjust the amount you save to reflect current increases in expenses.
Start Saving for the Unexpected Today
No one can foresee what the future holds for any business. But keeping business emergency funds acts as insurance against those unexpected events. Access to readily available funds can help you pay your company’s bills, make your payroll, and handle any emergency expenses.
Reach out to start a conversation with the First Bank & Trust, a division of HTLF Bank team today—together, you can strategize ways to financially prepare for the unexpected.
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