Why should you create an emergency fund?
A corporate emergency fund (also called capital reserves or retained earnings in the accounting field) can help you stay financially afloat when serious situations arise: things like sudden health issues, having a key employee go on leave or resign, being the target of a lawsuit, or having a slower-than-expected season.
In cases like these, you need enough cash set aside to keep the doors open for a few months while you deal with whatever issue has arisen.
These situations are not uncommon. According to data from the Federal Reserve, 66% of small businesses have faced financial challenges, with meeting operating expenses being one of the most common ones. What’s more, small business owners are more likely to exhaust their personal savings in an emergency to keep their companies afloat. When those are gone, not only is your business in trouble, but you may have trouble meeting your own living expenses.
Keeping an emergency fund, on the other hand, enables you to avoid incurring additional debt and prevents you from using up all of your savings and affecting your personal financial standing.
Finally, just as living paycheck to paycheck makes it difficult to be strategic with your personal finances, running your business from payroll cycle to payroll cycle can inhibit your ability to grow. Having business emergency funds as a buffer when needed will give you room to breathe and help you pursue expansion opportunities when possible.
How much should you save?
Most business advisors suggest setting aside at least three to six months’ worth of operational expenses as an emergency fund.
Most small businesses won’t be able to save that much right away, and that’s ok. Instead, start small and put away as much as you can every week, month, or quarter. Consistency is key. You should treat these payments into your business savings account the same way you would payments for staff, taxes, or other necessities.
When determining how much to save for your emergency fund, consider the following:
Receivables and inventory: Companies that carry inventory or have slow-moving receivables should have more on their emergency funds.
Business structure: Are you a sole proprietorship that has no employees? How much of your business activity is dependent on your employees? It’s important to consider the implications of losing revenue in terms of your capacity to carry on with activities.
Seasonality: It is best for companies that experience seasonal or cyclical fluctuations to put extra money aside for emergencies. More fluctuation in the business means that more cash may be needed in an emergency in comparison to a more stable business.
How to start saving for your business emergency fund
Research the best bank for your business
You can open a separate account for your emergency fund at the same bank or credit union where you already have a business bank account. However, you can also explore other banks if you would like to. Here are our recommendations for the best banks for small businesses.
While you may want to start with a regular business savings account, as your emergency fund increases over time, you might want to think about investing some of it into another account that offers a higher return (i.e a money market account). However, it’s still important to make sure you keep enough cash in your regular savings account to cover an emergency, should you need to access it fast.
Automate your savings
It’s easy to forget to move money manually into your savings account each month while juggling the many other tasks associated with running a business. That’s why we recommend automating your savings.
This way, you’ll be putting money aside regularly and growing your savings regardless of what else is going on with your business, and you can easily adjust the amount you save as needed.
The bottom line
Business emergency funds are an important tool for any entrepreneur, as they allow you to be more strategic with your business income, weather any financial storms, and grow your business with greater confidence. To get started, all you need to do is open a business savings account and make that first deposit.