For most business owners, last year was a giant dumpster fire. And if we learned anything at all, it’s that we have to be prepared for the worst (and the unexpected). Sure, there’s no way anyone could have predicted a global pandemic (or a global shutdown for that matter) resulting in businesses shutting their doors—and not just for a few weeks.
So, as business owners, how in the world are you supposed to prepare for the unexpected? Well, we’ve got three words for you: business emergency fund.
What Is a Business Emergency Fund?
A business emergency fund is a stockpile of money you have saved in a money market account—for emergencies, rainy days, or if you want to seek out new opportunities for your business. In the accounting world, this beautiful pile of money waiting for the next emergency or rainy day is often referred to as “capital reserves” or “retained earnings.”
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Just like a personal emergency fund, your business emergency fund will give you the confidence you need when crap hits the fan. And we’re not just talking about a global pandemic. We’re talking about if you get sick, have a prominent employee take leave, get dealt a lawsuit, or if your slow season is longer than you expected. It’s necessary to have cash tucked away that will keep the doors open for a few months while you do what it takes to bring in more business and more profits.
Why Does My Business Need an Emergency Fund?
An emergency fund won’t do your business any good if you’re not actually saving it for emergencies. And if your business is operating on a payroll-to-payroll or crisis-to-crisis basis, it’ll be difficult to get ahead.
Most business advisors might tell you just to take out another line of credit, a small business loan, or to dig into your personal reserves to keep the business afloat during hard times. But what happens if another economic shutdown comes along? Will you be able to pay back the loans at the bank if they come calling? Will your family be able to keep food in the fridge and a roof over your heads?
That’s where that pile of savings comes into play. It’ll keep your doors open so you don’t have to go further into debt (or dip into your personal accounts).
Should My Business Be Debt-Free Before I Start Saving?
If you’ve followed along with us for a while, you may have heard of a little something we like to call the Baby Steps. These, when done in order, take you from financial captivity to a life of living and giving like no one else. (If you need a refresher, catch up here.)
Now, you’re probably wondering, Do I pay off all my business debt before I start saving? Not exactly. If you’re a business owner, it’s important that you make a living wage like the rest of us. Don’t get too extravagant here, and don’t make your family eat rice and beans if you don’t have to.
After you pay yourself, it’s time to start paying down any business debt you might have. Now here’s where the Baby Steps might differ for business owners: you pay down debt and start saving those retained earnings at the same time.
You get to choose the ratio here, but we recommend that the larger ratio goes toward paying down debt and the smaller toward savings. For example, you might decide to use 80% of your profits for debt and 20% for retained earnings.
How Much Should I Save?
Your savings goal should be six months of business expenses (payroll, rent, office supplies, etc.). That may sound daunting if you’re a small business, but don’t be intimidated. There are plenty of ways to help you reach your savings goals—even if you’re operating on a small budget.
1. Set up an automatic transfer.
Open up a separate savings account (one that gains interest, like a money market account), and set up a monthly deposit. Not only will it grow month after month, but it’ll collect interest. Just put it somewhere you won’t be tempted to dig into unless it’s a true emergency.
2. Save even more when business is good.
Having a few good months can feel like you’ve won the lottery. It’s tempting to want to spend those extra funds on fancy new office chairs. Resist the temptation—unless your employees are sitting on the floor. Instead, use this opportunity to pour even more money into your reserves for when the unexpected happens.
3. No amount saved is too small.
Like we said earlier, saving chunks of money can be a hard pill to swallow—especially if your business is small and you’re still working out of your garage, living on beans and rice. It may take you some time to reach that six-month goal, but no amount is too little when you’re socking away money for the future.
When Can I Use the Money?
Remember when your parents gave you their bank card and said, “This is for emergencies only”? But instead of using it when you were stranded on the side of the road, you decided that being hungry meant you could order a pizza. Sorry to burst your bubble, but your emergency fund is for business emergencies only—not for the staff pizza party.
Your business emergency fund is for emergencies. Yup—much like the unexpected shutdown you had to endure in 2020. But it’s also for those months where business slows to a crawl. If you’re in the pool business, you’ll want to sock away money for the winter months when you’re not really servicing pools anymore. That money will help you get through the long winter months to keep the lights on and the doors open. Not only that but it could help if you decide to seek other business opportunities during the winter too. Let’s say you want to start flipping houses. You’ll be able to use some of your emergency fund to pursue that opportunity as another way to make income in those winter months. And on top of that, you can also use your emergency fund to take advantage of buying inventory (super cheap) or even try out new and exciting opportunities for your business—without going further into debt.
There are a thousand decisions to make each day as a business owner (like how much money you should have in your emergency fund). But you don’t have to fake it until you make it as you guess your way through each one. We’ll help you take the guesswork out of business by giving you a customized plan and online leadership training. You can do it on your own, with a group, or even with an executive coach. Take your business and leadership to the next level this year with EntreLeadership Elite.