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Small-business owners can find themselves in business emergencies in the blink of an eye. Being prepared can be key to remaining in business.
But establishing and maintaining business financial reserves can differ from creating a personal emergency fund. Your personal emergency fund can help you cover personal expenses during a business emergency that leads to loss of business income. A separate emergency financial reserve fund can help cover your business operations costs when business emergencies strike.
This can be part of your business continuity plan. This is a carefully structured written plan that clearly outlines the steps you'll take if your business faces an emergency that threatens its existence. Such emergencies might include natural and man-made disasters, fires, cyberattacks, power outages, mass terror events, and chemical or hazardous material incidents.
A solid emergency financial plan can help keep you in business and may help cover employees' salaries while you address the disaster. These tips can help you create and maintain one.
What Is an Emergency Fund?
A business emergency fund is a reserve of cash set aside by your business (usually in your business’s name and in its accounts) to help cover unexpected expenses or financial setbacks that may occur. It can help you fund immediate expenses related to your business continuity plan, like payroll, rent, utilities, and other fixed costs necessary to keep your business running.
The emergency fund's purpose and scale are uniquely meant to safeguard your business against unforeseen business disruptions like those mentioned above. But for businesses of all sizes and types, those disruptions can also include economic downturns, loss of a major client or customer, or urgent repairs. A business emergency fund may be larger because operational costs and expenses of a business can be higher.
Access to these funds can be tightly controlled and restricted to business owners and key financial officers, who can ensure they are used solely for significant, unplanned business expenses.
For businesses of all sizes and types, disruptions can include economic downturns, loss of a major client or customer, or urgent repairs.
Consider setting aside a minimum amount of 3-6 months' worth of your business's operating expenses. But because business expenses can be so large, you might fund the account until it can cover the most major operational expenses you’ll have in the immediate term after a business emergency.
During the initial phases of a business crisis, it may be challenging to get access to other funds like loans or proceeds from sales. Your customers may face their own emergencies and may not pay your accounts receivable, so you’ll potentially need that emergency cash. Here are some tips for setting up an emergency financial reserve fund.
How to Help Know Your Needs
There are several steps you can take to establish the business emergency fund you need.
- Determine your business emergency fund size. Calculate your fixed and variable expenses to understand how much it costs to operate your business monthly. Then set a goal for how much you'll save to cover 3-6 months of operating expenses. Depending on the volatility in your industry and your business's risk exposure, you might opt for a larger financial buffer. If yours is a smaller business with fewer operational expenses, you may only need a small cushion.
- Analyze your business cash flow. Determine how much money you can set aside each month realistically without causing an impact on daily operations. Also, you might consider funding sources besides operational cash flow like excess profits, rebates, business credit cards, or business lines of credit.
- Set up automated transfers. You can set up automatic transfers from your business checking account to your emergency fund accounts to make the saving process consistent and less likely to be overlooked.
It can be crucial to have ongoing discussions about this process with your business partners, management team, and professional advisors. They can help you see aspects that can have important implications for your business during an emergency.
How to Help Calculate What to Save
Here’s a way to calculate how much to save for your business emergency fund.
First, determine your average monthly business expenses, including rent, payroll, inventory, and other necessary costs. Then, after you decide how many months of cash you'll put aside, multiply that amount by 3-6 to get the total target amount for your emergency fund. Divide that total by the number of months you want to save to get the monthly contribution amount.
For example, if your average monthly business expenses are $10,000, a 3-month emergency fund would be $30,000 and a 6-month fund would be $60,000. If you want to save for a 3-month emergency fund over 12 months, you will need to contribute $2,500 per month.
You may need more depending on your business type and the kinds of emergencies your business might experience. A properly established business continuity plan can help you determine what you’ll need.
Where to Consider Keeping Your Emergency Fund
Choosing the right savings and investment vehicles can be as important as determining how much you need. A high-yield business savings account that offers higher interest rates while keeping your funds accessible may be a solid choice.
Also, you might consider business money market accounts. These might offer higher interest rates compared to traditional savings accounts and may come with check-writing privileges.
You can consider putting part of your emergency fund into a Certificate of Deposit (CDs), which may offer higher interest rates for locking in funds for a fixed period.
You can research and talk to other business owners about where they’re keeping their business emergency funds. You can ensure you choose an established institution with a good reputation. Building this fund is a long-term investment in your business.
Managing Your Emergency Business Funding
Managing your business financial reserve funds can help them be readily available when you need them. Here are several strategies that can help.
- Establish guidelines for use. You can start by defining clearly what constitutes an emergency for your business. This should align with your business continuity plan but can include equipment failures, sudden loss of a major client, or unexpected legal issues. You can put access controls in place that establish who can access the funds and under what circumstances to prevent misuse.
- Educate your team about the emergency fund. Communication can be essential here. You can make sure key members of your management and financial teams understand the purpose of your business emergency fund and the parameters for its use. You can document all policies related to the emergency fund in your business’s financial management and business continuity plan. Then, you can ensure those key team members have access to and understand those written policies.
- Keep the fund separate and protected. You can avoid commingling the emergency fund with other business accounts so you don’t use them for regular operating expenses. Also, you can evaluate and supplement your emergency fund with business insurance products that can help mitigate financial risks.
- Monitor and reassess regularly. You can reevaluate your emergency fund at least annually or whenever significant changes in your business occur, like expansion or a reduction in revenue. You might adjust contributions if your business grows or contracts to ensure the funds can cover the number of months you need.
When to Consider Using Your Business Emergency Fund
It can help to understand the distinction between routine business fluctuations and operating expenses and genuine financial emergencies.
These financial reserves can be a safety net to protect your business against severe, unforeseen economic shocks that threaten its ongoing viability. But what are appropriate and inappropriate uses of these funds? How do you maintain the fund while still using it during emergencies?
Define a True Emergency
A business scenario can qualify as an emergency if it poses an immediate threat to the core operations or the financial health of the business. These are situations you can’t manage with your normal operational cash flow. They’re usually events that are sudden, significant, and often beyond your control as a business owner, like a pandemic or major equipment loss.
Here are two examples of uses of your business emergency fund.
- Major equipment failure: Your company relies on specialized machinery for production, and this equipment suddenly breaks down, halting production. If repairing or replacing the machinery requires funds that exceed available operational cash flows, then using your emergency reserve can be justified to restore production and prevent further revenue loss.
- Sudden loss of a key client: If your business loses a major client or customer unexpectedly, as many did during the pandemic, that can have significant impacts on your revenue. You can use the emergency fund you established to cover operational costs while the business shifts its business model or finds new clients to replace the lost revenue.
Preserve the Emergency Fund
There are a few methods to consider so you don’t exhaust your emergency fund in an ongoing business crisis.
You can strategically assess and plan how the funds get used according to your predefined business crisis or business continuity plans. Make sure you maintain access controls so only those you’ve designated can spend the funds.
Before using your emergency fund, you can assess the total financial impact of the emergency. You can plan how much of the fund is necessary to use and set a limit to avoid draining your financial reserves completely. Also, you can determine if insurance or other emergency funds, like government programs, can help cover those costs.
Also, you can carefully document their use, keeping detailed records of why and how your business used the funds. This documentation can help in reviewing the effectiveness of the emergency fund, your business strategy for handling emergencies, and how to maintain an emergency reserve.
Replenish Your Financial Reserve
Once the emergency is addressed, you can prioritize replenishing the fund. Again, this strategy should be part of your business crisis or business continuity plan. You can have a clear, realistic replenishment plan based on updated cash-flow projections.
You can make regular contributions into the emergency fund as soon as cash flow allows, but adjust contributions to the emergency reserves, if necessary. This might include temporarily increasing the percentage of profits added to the emergency fund until it is fully restored. It also might mean reducing costs in other areas to prioritize your emergency financial reserves.
You can maintain established guidelines for using and replenishing your financial reserves to ensure you use your business emergency fund appropriately and effectively. That will establish the emergency fund's role as a protective financial safeguard while helping to secure your business’s long-term stability.
The Takeaway
Establishing emergency financial reserves can be essential for your small business. It can offer a shield against unexpected business expenses and even out cash-flow fluctuations. You may have greater peace of mind because you know you’re helping to ensure your business’s long-term stability and resilience against financial risk.
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