Financial advisors often suggest that individuals create an “emergency fund” that can act as a cushion in the event of unforeseen financial downturns, like job loss, medical expenses or home repairs. Knowing that fund can fill in any income gaps brings many people peace of mind.
The same can be true for businesses. Companies of every size experience unpredictability that may be challenging to address: sales slumps, employee turnover and workman’s comp claims. Even success can drain your cash reserves—for example, a large product order may require some upfront investment for covering manufacturing costs.
Similar to a personal emergency fund, a business fund can stretch across the gap that may form between your cash reserves and your expenses. Some companies opt for a line of credit to cover these sorts of expenses. A loan might make sense in some scenarios, but it’s also wise to have extra cash on hand.
Here are two questions to think about as you explore emergency funds for your business:
How much should I set aside in my emergency fund?
In general, it’s wise to put in enough money to cover a minimum of three to four months of expenses for your operation. To determine that number, take a look at your costs and expenses over the past few years and consider what would be enough if the company hit a major downturn—such as sales drying up completely, a product recall or departure of senior leaders.
This exercise is also helpful in assessing what’s most important for your business operations. If there’s a serious slump, can you cover employee salaries, or will you have to do layoffs? Are you at risk of being sued by a vendor or customer?
Thinking about emergency fund amounts can be useful for taking a fresh look at what’s working in your business—and what may not be.
How can you start building your emergency fund?
Similar to personal accounts, business emergency funds usually can’t be stocked full of cash right away. It may take some time to build up a fund. Then, maintain it by dipping in only when there’s a true emergency.
First, look at ways you can cut current expenses, and then direct the money you would have spent into your emergency fund. Strategies might include renegotiating with suppliers, switching vendors, using contractors for some positions instead of employees or sharing marketing costs with other businesses in your area.
Second, use high-profit months to build up your fund. It makes sense to try to put aside money every month, but you may be in a business with variable sales cycles. Capitalize on the months when you’re earning more by taking some of the profit and socking it away in your emergency fund.
Just as a stash of cash can bring confidence to individuals and families, the strategy can also be helpful for businesses. Putting some effort into building your emergency fund—with the hope you’ll never have to use it—can make you feel more confident about handling any unexpected financial snag you may hit on your way to business growth.
If you would like help assessing your need for an emergency fund or advice for growing your business, get in touch. We’re here for you and ready to provide support.
The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Sweet Financial and not necessarily those of Raymond James. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation