One of the first lessons that many business owners learn is that having an emergency fund is crucial to financial stability. The purpose of a savings account is to function as a financial vehicle, where you maintain a certain amount of money. That money, in turn, should be used to cover unforeseen problems in your life or business. It’s important to consider how to fund, allocate, and apply emergency reserves for your small business.
When something goes wrong, having an emergency fund could save you from losing your other investments, such as a retirement fund or investment accounts. It can also prevent other problems from stacking up on top of your existing troubles, such as more debt, bankruptcy, or loss of a home or business.
Choose a Timeframe
When it comes to choosing how much money to put away for an emergency, your first step is to decide on a length of time for your reserves to cover.
At the very least, your emergency fund should cover three months of expenses. That very bottom threshold should rise to six months of coverage if you have any dependents, such as family members, and it should be an even longer period of time if your business is a risky one or leaves you more prone to injury. Depending on your industry and how new/stable your business is, this will be the deciding factor on how much cash you should have in reserves. This will allow you more time to make informed decisions, and feel a little less stressed as you get back on your feet.
Though it may seem obvious, the general rule of thumb is that the bigger your emergency reserve, the less catastrophic any emergency will be. The catch is, there is an opportunity cost for having too much cash on hand. Saving a little extra money is almost never a bad thing, and the payoff in times of trouble can be a lifesaver.
Calculate Your Expenses
After you have chosen how long your emergency reserves should be able to last, you will need to calculate all the costs that that money must cover. Then you will be able to find a dollar amount to put in your savings account.
For a business, these expenses include things like buying materials, paying employees, phone and internet bills, maintaining the space you use and more. To find out the exact amount that all of this costs you, examine your cash flow statement.
In your personal life, these costs will be necessities like food, gas for your car, utilities, mortgage or rent, and insurance.
Figure out how much you spend on essential things every month, and then multiply it by the number of months you have chosen to cover with your savings. Keep in mind, though, that costs can change in emergencies. Some expenses that are normally static may go up or down since the way things are being operated has changed. In light of that, add a little extra money to cover all the possible unforeseen consequences.
Keep It Safe and Accessible
Now that you have determined the amount of money you need to save, the money should be moved into a safe, low-risk savings account that has no barriers to access. In other words, it is not wise to invest your emergency reserves in stocks or something that can fluctuate. Don’t put it in something that discourages withdrawal with methods like fees or heightened taxes. This emergency money must be liquid, because you never know when you will need to make a quick withdrawal.
Leave It Be
Finally, once you have your emergency reserves saved up and safely put away, simply leave the balance alone. Don’t use it unless you need to-it may be tempting, but this money is not for a shortcut. It is for things you can’t avoid.
Treat the fund like insurance. It is a backup to be used when you need it most, but it is better if that need never arises. For some companies, the simplest way to achieve a robust emergency reserve is to set up automatic transfers from the business account straight to the savings account. Another powerful tool is to hold the savings account separately from your other accounts. The saying “out of sight, out of mind” comes into play here. If you are tempted to use your savings to fund (or “invest”) in business ventures, it is easy to avoid the temptation when you do not usually even see your savings account balance.
Trust the Experts to Help You Establish a Robust Emergency Fund
Determining how to manage your savings as a small business owner can be a challenge. The professionals at Inflection Advisors would be happy to learn more about your unique situation and provide guidance to help you make an informed decision. Reach out to learn more or to schedule an appointment to get started.
