No matter which industry you are involved in, certain rules must be followed by all small businesses. These are the universal guidelines for managing and protecting business finances. Right at the top of this list is the need for a substantial emergency fund. If you were to ask nearly every small business owner for their most important piece of advice, it would likely be to consistently put money away. At some point, the average small business is going to run into trouble. It’s practically inevitable. So, even though you might not know what kind of situation you are saving money for, building an emergency fund should be among your regular responsibilities as the business leader. But, much like any other business-related initiative, building an emergency fund isn’t as easy as it sounds and should not be done without the right information.
When asked how big an emergency fund should be, the gut response is usually “as big as possible.” While it’s undeniably better to have more money put away than less, setting such a vague goal makes it seem harder to achieve. Here are four things to know as you build an emergency fund for your small business:
Business Expenses + Personal Expenses
The first step is fairly obvious, and that’s figuring out how much money you typically spend on your business within the span of a few months. This includes all monthly business expenses as well as extra costs. Odds are, recurring bills and payroll aren’t the only things you spend money on every month. There will always be additional business expenses, so you can’t exclude them from your calculations. Though you may be able to cut certain expenses, it’s usually recommended to envision having to spend more money than less. Better safe than sorry, right?
The data you look at should not be from months that were particularly busy or slow. It should be from three to four average months for your business. You may find that you have gradually been spending more money on your business due to external circumstances like rising, industry-wide demand.
Here’s where it gets tricky. Your business is probably your sole source of income. If this is the case, you must calculate a few months’ worth of your personal expenses as well. Your personal budget would be effected in the event of a business crisis. Which personal expenses would you be able to cut back on? Which personal expenses would you still need to cover if your business earned almost no money that month? Since your personal expenses depend on your business, your emergency fund should be able to cover your business expenses in addition to the personal expenses you would be unable to cut.
The Fragility Of Your Market
Certain factors may make it necessary to set aside more money than the previous two calculations suggest. One example is the nature of your products or services. Does your business cater to a very specific audience or fill a very small niche? Is your business highly seasonal and therefore prone to elongated slow periods? The more diversified your business is, the less money you have to put away. You have a logistically higher chance of continuing to earn a solid income following a sudden change in your target market or the entire economy. If anything, you’d just have to make some slight modifications to your products or services. Highly seasonal or specialized businesses, on the other hand, might want to set aside more money because their target market is more fragile.
Replacing Major Sources Of Income
Let’s say your business has just lost a major source of income. This could be a big buyer for a wholesaler, a vendor for a retailer, or a supplier for a restaurant. How long would it take you to replace that resource and make back the money you’ve lost? Remember, you’re not supposed to be optimistic with these calculations. Most thriving businesses would likely need at least three months to replace a lost source of income. If you think it would most likely take more time than less to do this, your estimated emergency fund might need a boost.
How Much Would You Be Able To Borrow?
Some emergencies are so extreme that even the most financially careful business owners are unable to cover the damage on their own, especially younger businesses. This is why companies like United Capital Source frequently issue small business loans to quicken a business’s recovery process. So, when building an emergency fund, you should also consider how much you’d be able to borrow. Besides, if you can get approved, combining a portion of your emergency fund with borrowed funds would likely be better for your personal and business finances than just paying for everything with your own money.
Unlike other business financing companies, United Capital Source is not reluctant to work with a business that has just experienced a crisis. We can modify terms and repayment structures to suit the estimated time frame of your recovery. As for requirements, you can probably guess what kind of businesses are most likely to be approved: Those that have clearly made an effort to prepare for this exact moment.