Most financial advisors tell people they need to have an emergency fund to cover unforeseen financial issues; job loss, medical expenses, or home repairs, that may occur in their lives. The same can be said for businesses, too.
Businesses can experience unpredictable challenges, as well as opportunities, in which they may require additional cash. While a loan or a line of credit might make sense in some of these instances, they also may not be a viable option for your business.
What Is an Emergency Fund and Why Do You Need One?
In accounting terms, an emergency fund is referred to as “retained earnings.” An emergency fund is cash your business saves to be used in the event unexpected expenses or a steep drop-off in business occurs. This extra cash helps you to continue operating your business during a crisis or when sales are lean.
Here are three reasons why your business needs to have an emergency fund:
- An emergency fund gives you immediate access to cash during a critical time. Some typical emergencies may be a natural or manmade disaster, an economic downturn, an unexpected medical situation that requires you to be away from work for an extended time, faulty product shipments, or computer glitches. While your business may be insured against some disasters that cause property damage, product loss, or equipment repairs, the insurance claims can take time to process. Or, your insurance policy may not cover everything. Therefore, you need to have access to cash to continue operating your business and make any repairs or replacements, if needed.
- Cash flow issues.As a business owner, you may go through periodic cash flow problems. For example, some business owners may rely on inconsistent income. Some months you may have fantastic sales while other months your sales may be sparse. However, you likely have consistent monthly expenses, like office rent, payroll, and utilities, you must pay. Other cash flow issues can arise when you experience unanticipated increases in facility or material costs. An emergency fund can help keep your business afloat during these slow times or while you temporarily handle increased costs until you can adjust your budget.
- Capitalize on opportunities. Sometimes, opportunities may arise for your business that you need to take advantage of quickly. For example, you may be able to buy out a competitor or purchase extra inventory at low prices. Ready cash can help you jump on these fortuitous occurrences.
How to Establish an Emergency Fund
You will need to set up a separate account from your regular business banking account for your emergency fund. While it may be tempting to put the cash in a certificate of deposit to earn interest, you need an account you can access easily during emergency situations. Also, you should avoid accounts with fees and early withdrawal penalties.
Additionally, for your bookkeeping, you need to set up a separate emergency fund account from your regular expense account. Your bookkeeper can help you do this. If you don’t have a bookkeeper, contact The Payroll Departmentin Brownsburg, IN. We offer convenient bookkeeping solutions at cost-effective prices.
Just remember: Your emergency fund must be off-limits except during certain circumstances. This will prevent you from dipping into it for non-emergencies.
How Much Should You Save in Your Emergency Fund?
In general, you should save enough cash to cover, at a minimum, three months of operating expenses. Depending upon your business volatility and other factors, you may want to consider saving up to a year’s worth of expenses.
To determine your savings goal, review your expenses over the past few years. Look at costs that are important to your business operations. Identify how much you would need to survive a major emergency to your company.
If you need help in calculating your monetary goal, Grace Walker of The Payroll Department can assist you in reviewing your monthly budget. She can help you figure out what’s vital to keep your business buoyant during critical times.
How Do You Start Saving Funds?
Since you likely won’t have the cash to fund your emergency account in one lump sum, it may take several months to accumulate the money you need. One way to start saving money is to look at ways you can cut current expenses. For example, you may want to renegotiate prices with your suppliers, or you may want to hire contractors instead of employees for some positions. Grace Walker can help you identify areas within your business in which you may be able to save money. Any extra cash should be placed in your emergency account.
Another option is to put aside more money in your emergency fund during those months in which you’re making more profit.
Additionally, Grace Walker can help you establish a savings timetable, so you know exactly how much you need to save every month.
An Emergency Fund Gives You Security
By creating and building your emergency fund, you can feel more confident that you’ll be able to handle any unexpected financial emergencies that may arise, so you can continue to grow your business.
If you need help setting up your emergency fund, call Teresa Ray at The Payroll Department at 317-852-2568. We’re here to provide you with bookkeeping support to help your business maintain its financial security.
– Ariane of The Payroll Department Blog Team