The importance of an emergency fund for your business
Having an emergency fund for your business provides a safety net to weather the bad times and confidently invest in your business in the good times. Though you can plan for some business risks (such as business seasonality), any number of unforeseen emergencies can impact your business, including a key employee leaving the company, a change in supplier, or a global health crisis such as COVID-19.
Establishing and maintaining a healthy business savings fund requires diligent planning and consistent monitoring. Here we will review the key elements of planning and establishing an emergency fund for your business that will help you better manage your business risk.
To establish how much you need to have saved, you first need to determine what expenses are essential to your business. Some essential expenses to include (but not limited to) would be:
You should consider all non-negotiable expenses needed to keep your business going even during a temporary business closure. Keeping your rent and utilities current are just as important as taking care of your employees as you don’t want anyone jumping ship when you need them most.
Also calculate non-essential expenses that you could target quickly and easily eliminate, should the need arise. Non-essential businesses expenses include business travel (substitute phone/web meetings), office supplies, subscriptions, marketing, and office improvements to name just a few.
Be sure to outline and calculate all expenses and categorize them as essential, discretionary or non-essential. Review this information with your CPA or bookkeeper to get their insights and document this information.
Once you have documented all your expenses, calculate the amount you need to save. The standard recommendation is to have 3-6 months of expenses saved, but having up to 1 year of expenses saved is advised given the current economic environment. This time frame depends on the type of business and if it is seasonal. Some businesses need to plan for periods of slow business (i.e. ski lodges, ice cream shops, etc.) and for general seasons of reduced spending, such as in January when consumers may reduce their spending after the holidays.
Calculate your monthly expenses (include annualized expenses), remove non-essential and discretionary expenses, then multiply that number by the number of months you want to save for. So if your essential monthly expenses are $18,000, then for a 6 month emergency fund you would want to have $108,000.
Planning and saving for an emergency fund may seem daunting at first, especially if you are a small business or new business, but establishing a simple plan and sticking to it will quickly get you to your target savings fund.
Start small and automate your savings. Establish how much of your monthly net profits you can set aside in an emergency fund and set up an automatic transfer into this separate savings account. Automating this savings process will keep you disciplined and you don’t have to constantly think about it. Be sure to evaluate your savings transfer and increase the amount when you can, especially when sales are good and you have extra funds. Also consider saving some or all of any tax refund money your business receives into the emergency fund.
Some important best practices when establishing an emergency fund is to keep it separate and use it only in a true emergency. Stay disciplined with your savings practice and do not use it unless it is absolutely necessary to keep the business running. Also keep your business and personal savings separate. This is important to track what is allocated for your business versus your personal needs.
Consider other resources and best practices that can supplement your cash flow needs. Opening and maintaining a business line of credit can help with cash flow needs throughout the year, but also serve during more challenging times without dipping into your emergency fund right away. Evaluate your business travel budget and identify opportunities where business meetings can be done through alternative channels (online or on the phone). Review your marketing budget and spending to see how you can leverage your spending more effectively, such as online and through social media (where tracking ROI on marketing is much more concrete).
Establishing a savings plan and automating it is essential, but don’t set it and forget it! Your business will evolve and grow, and so will your savings requirement. Be sure to continually monitor your income and expenses, and adjust your savings plan as needed. You may need to increase your emergency fund as your business grows so evaluate your savings plan with your accountant at least twice a year.
Our experienced business bankers at HOMEBANK are available to help evaluate your business accounts and financial needs. Contact us today to discuss your business plans and let us join you on your journey to business success!