Small Business Emergency Fund: Preparing for Financial Needs

Just as an emergency fund is essential when it comes to your personal finances, an emergency fund for your small business can help your business survive setbacks. The average business has about 28 days of cash. And in a Federal Reserve survey of business owners, 17% of business owners said if they faced two months of declining revenue, they should close. A business savings account can be a lifesaver. Find out how to create a company savings fund.

Why small businesses need an emergency fund

The coronavirus pandemic that hit the United States in 2020 made the need for an emergency fund very clear. Many businesses were forced to close or relocate their business operations within weeks, and those that had cash in the bank were in a much better position to adapt than those that did not.

In the 2020 Federal Reserve Small Business Credit Survey (SBCS) released just before the pandemic, 66% of employing businesses said they had faced financial difficulties in the previous 12 months; the most common challenge was paying for operating expenses (43%).

As the pandemic has forced entrepreneurs to think about creating an emergency fund, it’s something that should be part of building a financially sound business. There are many good reasons to have funds available in your business savings account, including to pay:

  1. Unforeseen expenses,
  2. Working capital if sales suddenly slow down,
  3. Tax account higher than expected,
  4. Increase in the cost of supplies,
  5. Inventory, equipment or supplies at a reduced price if an opportunity arises,
  6. Increased staff payroll for important work,
  7. Repairs after a physical or natural disaster,
  8. Unforeseen legal fees,
  9. Costs not covered by insurance (in case of theft, data breach, etc.)

Of course, this list is virtually endless, and these are just a few of the many reasons why an emergency fund is so important.

Types of emergency funds for small businesses

A business savings account is an ideal way to save for the unexpected. Some even pay a small amount of interest. Where you have your business checking account is a great place to start. Remember that some business savings accounts have minimum balance requirements in order to avoid service charges.

As you build your savings, consider a money market account or even a certificate of deposit. Not only will you earn interest, but the potential penalties for withdrawing money early may encourage you to avoid mining these funds.

A business checking account with sub-accounts is another option for setting aside funds for savings. Checking account sub-accounts allow the business owner to dedicate specific amounts to goals and keep those funds separate from the main checking account.

Backup options include a line of credit or a business credit card, both of which can be used for short-term cash flow needs.

A line of credit often offers a larger credit limit, but can be more difficult to obtain, especially for startups.

A business credit card also offers a line of credit, but interest rates can be high if you have a balance. A 0% APR credit card can be a good option for lower cost financing for a year or more.

Microloans through Community Development Financial Institutions (CDFIs) are another option for business owners who have difficulty meeting eligibility criteria for bank loans or other traditional financing.

Business insurance can also help you avoid emptying your savings account for a covered expense. Whether it’s a burst pipe in your building, an accident on your premises or in a work vehicle, or a data breach requiring significant mitigation expenses, commercial insurance that covers these scenarios can prove invaluable.

Finally, many business owners rely on their personal funds to help the business cover shortfalls. The 2020 Small Business Credit Survey mentioned earlier found that almost half (47%) of business owners said they would use personal funds in the event of a loss of business income. It’s far from ideal. If your business is in financial difficulty, you risk losing your business income as well as the money that you will have to recover personally if you decide to close the business.

How much money should your small business have in an emergency fund?

Most business advisors recommend saving at least 3-6 months of operating expenses in an emergency fund. However, when you’re first trying to build an emergency fund for your business, saving the recommended three to six months of expenses can seem daunting.

Do what you can, but be consistent. Make payments to your business savings account just as you would to pay employees, taxes, or other essential expenses.

As the pandemic has illustrated, six months of operating expenses may be the minimum amount you’ll want to save. Saving more than that will give you greater peace of mind and also give you the flexibility to take advantage of your business growth opportunities.

When to use your emergency fund

Separating your business savings from your business operating expenses can help you avoid tapping them for day-to-day expenses (rather than true emergencies). When deciding when to use these funds rather than a line of credit or another type of loan, ask yourself if you will be able to repay the financing in less than six months. If you can, you may want to access credit rather than use your savings. ]

It’s also worth thinking about what will happen if you don’t tap into your emergency fund. Could you defer the expenses you encounter without causing long-term damage to your business and without falling behind on paying your business debts? Can you get creative to generate sales faster? Do you have customers who owe your business unpaid invoices and is there a way to get them paid faster? Can you temporarily reduce expenses or discontinue non-essential services to save money?

You may want to consult your accountant, financial advisors or business mentor for their advice as well.

How an emergency fund fits into your business financial plan

An emergency fund should be an essential part of your business financial plan. If you run your business as a personal account and only withdraw cash when it’s available, or have operated without a financial cushion, creating the discipline to save will benefit your business in the long run.

As you build your savings account, you may need to rely on credit. Having access to a low-cost line of credit or even a company credit card (perhaps one with a 0% APR) can provide you with short-term funding in an emergency.

The key is to align funding before you encounter a crisis. The application process can take time, especially if you are seeking funding from traditional financial institutions such as banks. (Online lenders generally offer faster approval.) You’ll have more time to research the best financing, and your business should be in a better position to qualify for a small business loan or line of credit.

Small Business Emergency Funding Programs

Following the COVID-19 pandemic crisis, a number of relief programs were quickly launched to help affected small business owners, including sole proprietors and independent contractors. These included the Economic Disaster Loans and EIDL Grants program, with grants of up to $10,000 that did not have to be repaid. (This was later expanded to include Targeted Advances which were grant funds available to the hardest hit businesses.) These programs were offered to eligible businesses through the US Small Business Administration ( .

Congress also allocated funds through the Paycheck Protection Program (PPP) which offered low-interest loans. These loans were eligible for forgiveness if business owners spent their PPP loan funds properly, primarily on payroll.

EIDL and PPP are closed to new applications.

Additionally, state and local governments, economic development agencies, private businesses, and nonprofits have offered covid-19 relief programs in the form of low-interest loans or grants. to small businesses. For example, Accion’s Small Business Relief Fund has provided financial assistance to nearly 4,000 small business owners.

If your business is still struggling due to the pandemic, check with your local SBA resource partner (such as your Small Business Development Center or SCORE) to find out what relief programs may still be available in your area. They can also provide free mentorship and advice to help you grow your business.

This article was originally written on January 31, 2022 and updated on February 1, 2022.

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