Despite the fact that small businesses are uniquely positioned to pivot in the face of changes in their market, it’s a fact of life that unexpected events may cause your cash flow to be temporarily altered, suspended or limited. Whether these occurrences are due to mismanagement, natural forces, supplier conflicts or the impact of broader economic trends, it’s incredibly important for businesses to have a “rainy day fund” or other type of business emergency fund available to get through the worst of it and maintain operations.
Much like the types of emergency funds that individuals are encouraged to put money aside to develop, business emergency funds are designed to protect your small business by diverting an amount of cash from your earnings into a secondary account or location, so as to be accessible if problems arise. They require discipline to set up and manage, but once you fall into the pattern of saving just a bit of extra business income, they are effectively able to be automated through your banking services.
The big question for most small business owners is: “how much do I put aside?” How much you put in your business emergency fund will determine if your company has the wherewithal to respond to bumps in the economy—or big, unexpected expenses—without falling behind on bills or resorting to measures such as discounting to generate cash or employee layoffs to slash expenses. Personal finance experts advise that individuals keep anywhere from three to six months’ worth of their fixed expenses saved in an emergency fund, and the same rule roughly applies to most small businesses, though depending on the obligations your business may need to cover, some analysts suggest that up to one year’s worth of savings is recommended.
Other tips for emergency fund preparation include:
- Keeping a secondary account, separate from your main expense account
- Starting with small contributions so as not to negatively impact your cash flow
- Potential investment in low-risk bonds to grow your money
- Setting positive goals for your retained earnings that will allow you to look ahead to emerging opportunities as well as being prepared for unforeseen challenges.
From a business perspective, it can also be ideal to have a credit line that can be tapped for emergencies and to help level out cash flow over time. Many business will look to solutions such as merchant advances to help them out in times of volatility, seasonality or expansion into new markets with potential risk. A merchant advance will give your business the option to have extra cash on hand without putting a drain on your day-to-day operational cash flow.