Importance of emergency fund

If the pandemic taught us something in business, it was to expect the unexpected and as with life in general you need to ensure that you have a financial backup when life throws you curveballs. This is where a business emergency fund will be invaluable.

What is a business emergency fund?

Put it simply, it’s a stockpile of money in your business to deal with any emergencies. Often it can be call retained earnings or capital reserves.

Why does a business need an emergency fund?

Every business should have an emergency fund to bridge the gap when your business is affected by unexpected events. Financial changes in your business can be due to a number of things like:

• changes in regulations.
• issues in the economy.
• health issues.
• family issues.
• natural disasters (fire, flood etc.).
• technology issues (cyber-crime).
• legal issues.
• or a global pandemic!

The solution to ride out the unexpected changes in your business is to have a business emergency fund.

How much should I have in an emergency fund?

Our advice would be to have at least 10% of your annual revenue in an emergency fund in your business bank account. Some businesses keep up to 30% of annual revenue in the bank to aid cashflow when needed as well as be prepared for emergencies.

How do I determine the amount?

By putting away a % of your revenue, it means you have some money to pay the business bills or potentially pay yourself if you arent getting enough revenue. The amount is usually influenced by preference and financial situation in your business. Get started calculating the cost of running the business. List the total monthly expenses for overheads and fixed costs and then consider variable costs also. You should look to have a fund that would cover anywhere from 3 months to 6 months of your business costs.

Benefits of building an emergency fund

Having a business emergency fund gives you many benefits:

1. Less sleepless nights! Knowing your business future is more secure will undoubtedly relieve some of the worry and stress if your business situation changes.
2. You’ll still be able to pay the bills. Ensuring you can still pay your monthly operating costs and keep trading is essential. Whether it’s paying overhead costs, software costs or suppliers bills, you need an emergency fund to be able to cover these.
3. Keeps your personal savings safe. Having your business emergency fund will avoid you having to prop up your business with personal savings.

How do I save a business emergency fund?

Firstly you need to be clear on how much you need. Maybe you’ll decide to keep 3-6 months’ worth of operating costs or 10% of your annual revenue. Whatever the figure, be clear on what you need to save.

There are some tactics you can use to save and build this emergency fund over a period of time including:

• Keep or do a funds transfer a small amount from each invoice/ transaction and put on one side or into a separate savings account, but one that will allow you quick access.
• Set up automatic transfers to this separate account– just like in your personal life every month save or transfer an amount automatically.
• Evaluate your costs regularly. Do you know what your monthly operating costs are and do you review them regularly? So many businesses or sole traders continue to pay for things they no longer use. Cutting costs will give you more funds to keep for an emergency.
• Put larger sums away when business is good. If you can transfer small regular amounts that’s great, but if you can’t and you have a good few months of trading, then use this period to put some larger chunks of money aside.
• Build in fluctuations for seasonality. If you’re business is more seasonal for example a gardening business, then you need to put more money aside in your business period in the summer to cover you during the winter.

When to use your business emergency funds

It seems obvious but your emergency savings are for emergencies ONLY! Use it to pay the bills when your income drops or as a safety net for unforseen expenses. You may also consider dipping into it to fund other business ideas or to diversify your business if this will help you through leaner times. Sometimes it could be a good idea to use it to buy stock or supplies at times when they are cheaper or in bigger quantities.

Additional funding to your emergency fund

If the worst case scenario happens and you get unexpected expenses or your business is struggling and you need to begin using your emergency savings or you haven’t accumulated enough money to cover the rough period your facing, then you can also explore other funding options including:

• Friends & family.
• Bank loan.
• Government loans and grants.
• Extending payment terms with suppliers.

Summary

If you want a sustainable long-term business, then building up a business emergency savings is necessary. It can be difficult to know how much your business needs to put into an emergency fund and difficult to build up when you initially start a business. It can be the difference between surviving challenging time or seeing your business through a lean period. No matter what issue arises, you’ll sleep better at night knowing you’ve got money set aside and your short term money worries are covered. If you want help and advice on building a business emergency fund, then contact us today by calling us on 03330 886 686 or e-mail us enquiry@dnsaccountants.co.uk.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.