Don’t have a small business emergency fund or struggling to grow yours? Unfortunately, one in four small businesses has less than a 13-day cash reserve buffer per JP Morgan research, and many don’t have anything set aside at all. While the reasons for this are entirely understandable, a lack of cash reserves can make or break your business.
On this page, we’ll explore why it’s important to have an emergency fund, how much extra cash a typical business needs to set aside, and practical tips for growing your company’s reserve fund, so it’s easier to get started.
What is a Business Emergency Fund, and What is it for?
Sometimes referred to as cash reserves, a business emergency fund is cash you’ve set aside for unexpected expenses or periods when your cash flow slows.
It’s also different from your general business savings account. Whereas your savings account should be left untouched in emergencies and allowed to grow, your emergency fund can be dipped into as needed to ensure you can cover day-to-day business operating expenses.
5 Reasons to Create a Business Emergency Fund
The median small business has daily cash outflows of $374 and inflows of $381 on average, per JP Morgan research. According to their research, the typical company has $12,100 in reserves.
If we crunch the numbers, we can see that $374 in outflows equals $11,220 per 30-day month, so a typical business can’t survive a month without its regular cash flow and won’t survive very long with diminished cash flow either.
But, again, this is only a “typical” business. Those in labor-intensive or low-wage industries tend to have lower inflows and lower cash reserves than their counterparts. It’s harder for certain small businesses to build cash reserves and that much harder to bounce back from emergencies.
This is no doubt why 82 percent of business failures are linked to cash flow issues, according to the National Federation of Independent Business (NFIB). Building a business emergency fund is essential to the longevity of your business, but it’s not just about whether your doors stay open. Your cash reserves influence lots of different areas that relate to the overall health of your business. Let’s take a quick look.
1. You Have Greater Peace of Mind
More than a quarter of small business owners lose sleep over cash flow and about a third say they’re “drowning” in receipts, according to a Staples poll. Setting aside an emergency cash fund can provide peace of mind that, no matter what your business is up against, you’ll come out strong.
2. Your Savings Remain Untouched
Savings are intended for growth initiatives, such as purchasing real estate, buying equipment, or marketing and operations investments. When you draw from your business savings account or even your personal funds, because you’re facing a financial emergency or simply can’t cover daily business expenses, you’re basically stealing from your business’s future. Cash reserves keep your savings intact, so you can build a stronger company.
3. You Have Access to Cash in Critical Times
Throughout virtually the entire time Google Trends has tracked interest in specific terms, the phrase “I need emergency money” has received the same number of searches. In other words, people are always running short on cash regardless of what’s happening with the economy or impacting small businesses.
Unfortunately, when people hit the point in which they’re looking for quick cash, they’re usually in a desperate situation. They need cash to cover payroll today, can’t afford to repair equipment that’s critical to business operations, or facing another challenge that may determine whether their doors stay open. With the strict approval requirements, the long application process, and the stretched payout timelines that are common with financial institutions that offer traditional loans, business owners who can’t afford to wait, seek alternative financing options. That also means the business owner is vulnerable to accepting terms that aren’t in the best interests of their business.
When you have emergency reserves, you’re not only able to weather unforeseen events better but come out stronger than your counterparts because you don’t get caught in debt traps – the vicious cycle of making interest-only payments to keep accounts current but never reducing the balance.
4. Your Cash Flow Issues Aren’t a Problem
Most businesses have cash flow cycles that wax and wane. For example, you may peak during the holiday season and see reduced inflows during the spring. At least some of the extra income generated during the peak season should be held to see you through the slower months, or you’ll find yourself seeking necessary funding. Your cash reserves are great for this purpose.
5. You Can Capitalize on Business Opportunities
Sometimes, businesses get a small window in which making an investment will dramatically increase revenue. For example:
- Volume discounts from vendors
- Overstock discounts
- Mergers and acquisitions
- Growth initiatives
You can easily make these types of investments when you have cash reserves, and your business will grow stronger as a result.
How Much Should You Save in Your Emergency Fund?
How much to set aside in your small business emergency fund will vary depending on your goals and situation. Generally speaking, you should try to set aside three to six months of your outflows.
How to Build a Business Emergency Fund
Setting aside three to six months of your cash outflows for a small business emergency fund may sound like a pipe dream, but it’s easier than you might think, and it doesn’t have to happen overnight.
Determine the Amount You Need
Start by calculating your big-picture goal or the total amount your business needs to set aside in cash reserves. Again, if you run a typical small business, that could be anywhere between $11,220 and $22,440 or three to six months of your outflows. This figure may seem daunting, but you’ll break it down into smaller goals in a later step. This is only to give you an end goal so you know where you’re going.
Decide Where to Keep Your Emergency Reserve Fund
Most small business owners (65 percent) report having a secret hiding place for their emergency money, according to the Staples poll. Nearly half wouldn’t disclose the location, while 19 percent say they stash their cash in a desk drawer, 13 percent keep it on them, and seven percent hide it in their car. None of these places is secure.
Instead, it’s best practice to keep your cash reserves in a place like a:
- High-Yield Savings Account
- Money Market Account
- Certificate of Deposit (CD)
- Traditional Bank Account
These all keep your cash secure and can help you grow your reserves at the same time. Just be aware that some options, like CDs, lock you in for a set period of time, and there may be penalties for early withdrawal.
Set Monthly Savings Goals
Setting monthly savings goals is what makes reaching your overall goal realistic. If your cash flow cycles are predictable, it’s relatively easy to identify what ten or 20 percent of your monthly profit looks like and select a figure that works for you. If your cash flow is irregular, you may need to set a variable goal that fluctuates with your anticipated profit.
Start Depositing Funds into Your Cash Reserve
Begin by choosing a deposit schedule and start paying your emergency fund just as you would any other payable that comes your way.
Let’s say your emergency fund goal is $11,220. That’s three months of outflows for a typical small business. In this example, there’s only a $7 daily difference between your inflows and outflows, so you apply all of it toward your emergency fund. That means you’re stockpiling $210 per month or $105 per deposit if paying your emergency fund in two monthly installments.
When you focus on this smaller goal – depositing $105 twice per month – it’s much easier to meet your goal than it is if you’re only focused on the big-picture goal.
True, in this scenario, it will take just over 53 months (about 4.5 years) to reach your big-picture goal, and that’s only if you never draw from your reserves during this time. However, each step you take toward this goal is a win. Each dollar you have set aside is a dollar that can help you weather a small emergency or a dollar you won’t have to borrow if you hit a financial wall.
It’s also important to remember that your business will be growing during this period as well, and with growth comes greater outflows. You’ll need to increase your big-picture goal and micro-goals over time because of this.
Invoice Factoring Provides Quick Access to Cash
Businesses may need quick access to funding for a variety of reasons. You can easily run short if you’re growing, hit a seasonal lull, are facing an emergency, or if your clients are paying slowly. If you don’t have your emergency fund set up or you don’t have enough in your cash reserves to cover it, you will need some form of business funding to get through the crunch.
In these situations, invoice factoring is ideal because it turns your unpaid B2B invoices into cash. There’s no debt to pay back because your clients pay the balance when they pay their invoices, and it’s flexible. In addition, you’re in control of which invoices you factor and when to factor them.
Supplement Your Business Emergency Fund with Factoring by Charter Capital
With decades of experience, competitive rates, and flexible terms, Charter Capital can help your small business breeze through the issues associated with low cash reserves and grow stronger over time. To learn more about supplementing your small business emergency fund with factoring or to get started, request a complimentary rate quote.
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