Unfortunately, a lot of uncertainty still plagues the world of small business financing. Owning a small business, especially in its early stages, has never allowed an entrepreneur to assume smooth sailing ahead. Because of this, putting away some of your small business’s revenue for unforeseen choppy waters is a great idea. Though it might be difficult to get yourself to set aside large amounts of money for later needs, you’ll certainly never regret it.
That’s why an emergency fund, or “retained earnings,” is crucial to small business operations. Whether these funds will keep your business running during harder times or help you recover from an unplanned, costly event, it will inevitably be something you’ll be glad you have.
Here are a few tips for setting up an emergency fund and deciding what you’ll spend it on.
Starting your emergency fund
The process of creating an emergency fund for your small business essentially boils down to one thing—locating money that you can put away. Whether you choose to save more, make more, stow away your tax returns, or all of the above, it’s all about reallocating excess expenditure that you can save for when you might really need it.
The rule of thumb is to save enough for three to six months of operation; however, these numbers are a bit arbitrary when every small business operates so differently. Instead of following this catch-all rule, decide what kinds of financial risks your small business is facing and develop your ideal number from there.
If you run a business that is particularly vulnerable to lawsuit or accidents, keep that in mind when you decide your ideal emergency fund balance. But at the end of the day, this is an emergency fund, so always try to err on the side of caution by rounding up.
The easiest way to start is by pinpointing unnecessary expenditures and whittling them down. Look into your company lunches, your business trips, and your day-to-day spending and ask yourself if all of it is completely essential. You more than likely answered with a hesitant, “No,” so turn this new self-awareness into action. Schedule a video meeting rather than that trip to the opposite coast, and go to a park for a company outing instead of an expensive, sit-down lunch. The savings that will inevitably pile up should go straight into your emergency fund.
At the same time, you can also try to ramp up the amount of money your business makes in order to have the funds to stow away some money for an emergency fund. Whether you have a sales team to incentivize or it’s just you to motivate yourself, try to create a larger margin of profit that you can promise yourself to put away for a rainy day.
Finally, every year, an easy and nearly automatic addition to your small business’s emergency fund can be its tax return. Budget your business without taking your annual return into account, and then, no matter how large or small it is, it will always be a steady addition to your emergency fund.
Storing your emergency fund
So, now that you know how to accumulate the money to store away for emergencies, you’ll need to know where to put all of these excess savings. Your first instinct might be to put this money somewhere where it will make you more money. However, storing this money as stocks or as any other high-risk, non-liquid form might defeat the purpose of having an emergency fund in the first place. In fact, storing your emergency fund in such a way might even cause an emergency.
Because you want your emergency fund to be both safe and easily accessible, steer clear of any risky, non-liquid ways to invest the money you’re storing away. Instead, look to savings accounts and Certificates of Deposit in order to have your emergency fund available within a moment’s notice.
That being said, be sure to also have a distinct place where you can sequester your emergency fund. While you want your savings to be easily accessible, you also don’t want to have this money you set aside mixing and mingling with the money you’re planning on spending for you small business’s everyday operations.
Finding the right balance between accessibility and separation from spending money for your emergency fund will help shape how you consider it and, ultimately, how useful it will be in your small business’s potential time of need.
Spending your emergency fund
This question of balancing accessibility and separation brings us straight to the final consideration for your small business’ emergency fund—what will it cover? When it comes to spending the money you manage to stash away, be sure to treat your spending from the emergency fund with the purest definition of the word “emergency” as possible. That is to say, avoid spending on foreseen costs like monthly bills unless doing so is crucial to your business’s survival. This, of course, doesn’t mean you have to squirrel away loads of money that you’ll only allow yourself to spend if a natural disaster strikes your small business.
In fact, cashing out your small business’s emergency fund doesn’t have to be contingent on a disaster or even slow business. You might want to use your “rainy day” fund for a sunny day when you find a stellar but limited-time bulk deal on some inventory your business requires or when your business faces a costly, yet game-changing, opportunity that it wouldn’t have been able to take without the funds you so diligently saved.
At the end of the day, whether you’re starting your emergency fund, storing your emergency fund, or spending your emergency fund, you know what’s best for your own small business, so follow these suggestions while also keeping in mind your business’s unique way of operating.
Meredith Wood is the editor-in-chief at Fundera, an online marketplace for small business loans that matches business owners with the best funding providers for their business. Prior to Fundera, Meredith was the CCO at Funding Gates. She is a resident Finance Advisor on American Express OPEN Forum and an avid business writer. Her advice consistently appears on such sites as Yahoo!, Fox Business, Amex OPEN, AllBusiness, and many more.