Many personal finance advisors will tell you to build an emergency or rainy-day fund to carry you through bad days should you lose your primary source of income. However, did you know that entrepreneurs also need an emergency fund for their businesses?
Since the business world is uncertain, your business may be affected by factors such as industry developments, social trends, and economic changes that could unexpectedly affect your operating plan.
In ideal cases, you would want these factors to affect your business positively, but what will happen if unfavorable changes happen? The chances of your business adapting and rising from the challenges may depend on the tools you have to cope.
One arsenal you have is the business emergency fund, which often covers at least three months of your expenses. If you are wondering how to set it up, worry not because this article will help you.
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Steps For Creating a Business Emergency Fund
Most entrepreneurs face the hurdle of determining where the money for the emergency fund will come from. With rising inflation, businesses run on a thin profit margin, and setting funds aside for eventualities can cause anxiety for an entrepreneur.
Nevertheless, you can find practical ways to cut business expenses and put the money saved into an emergency fund. Here are the steps:
1- Know How Much You Need
The first step to creating a business emergency fund is knowing how much working capital you will need to keep your business afloat during hard times. You can determine this amount by calculating the main expenses of your venture.
Your business will still need to care for certain expenses even under challenging economic situations. Some of these expenses include:
Salaries for core staff: During bad times, most business scale down operations and retrench most employees. However, your business will still need a dedicated team to keep operations going as you figure out how to get out of the turmoil.
You should save at least three months of your core employees’ wages to keep operating.
Notice period wages for non-critical staff: You will inevitably let go of some employees during a downturn in business. However, you will still need to pay these employees when you give them notice to search for a new job.
Fixed expenses: While you can cut or skip some variable costs, others are critical and cannot be avoided. These include insurance, rent, and licensing, so ensure you save on these expenses.
Of course, some variable costs associated with the core operations, like shipping and marketing, will still be needed.
Accounts payable: Although the amount for accounts payable is not static, you should set aside an average amount to pay them; otherwise, supplier debts will give you sleepless nights.
Once you know the total amount you need to save, start doing so, and don’t stop even if you have reached your target. Economic “winter” will come, and you may not know how long it will last!
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2- Anticipate Slow Periods
If you knew exactly when your business would experience a downturn, you would prepare adequately. Unfortunately, most of these hard times come unexpectedly, catching entrepreneurs by surprise.
However, you can study business trends to determine when most similar businesses will likely encounter downtime in sales, especially immediately after the holidays or during season change.
You can collect data on the previous downturns and prepare accordingly for the upcoming ones. With this knowledge, you will know how to handle challenges without making rushed decisions.
3- Build a Decision-Making Process
Another challenge entrepreneurs face during a downturn is making sound decisions. If you do not anticipate bad times, you may panic and make unwise business moves or be paralyzed and make no decision.
Either course of action is disastrous for your business. So, how do you prepare? Practice rigorous decision-making during good times. You could adjust where you think the company is overspending and cut costs.
Rigorous decision-making skills will help you evaluate your purchases and other areas where the money goes. This way, you can know how to spend when funds are scarce wisely.
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4- Know Your Business Needs
Building a business emergency fund is no walk in the park. It may look like another expenditure because you take money from the business for future eventualities.
As you build the fund, business needs should take precedence. Start saving early in small bits so you don’t stretch your resources for necessary expenses.
Ensure you handle your business’s immediate needs and use leftovers for savings.
5- Set Aside At Least 10% Of Your Earnings For The Emergency Fund
If you don’t have any leftovers after handling immediate needs, you may wonder how to build an emergency fund. Some entrepreneurs may also have excess earnings but do not want to commit all of it to the fund.
How much can you save for eventualities? The figure may vary from business to business; however, the general rule is to save at least 10% of your monthly revenue into a rainy-day fund.
Since 10% is relatively small, you can use the excess to handle other expenses. Businesses with limited monthly revenue can also squeeze themselves and save this amount.
It is good practice to auto-save this amount because you can easily forget about it. Businesses have many expenses that take money out, and because emergency funds may be needed later in the industry, you may fail to keep them or remember them when you have used all the earnings.
Auto-save will ensure the money goes to the kitty before you use it.
6- Adjust Your Budget Monthly
Adjusting your monthly budget to meet the needs of your saving plan is essential if you are to remain motivated.
There are some months when it may not be possible to put 10% of your earnings on the emergency fund, so adjust accordingly. Similarly, some months you will have an abundance that allows you to save more into the fund.
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7- Have a Fallback Budget
A rainy-day fund should only be used during a time of crisis. Your budget during this period is not the same as the regular one, so ensure you have created a fallback budget that will guide your hard times.
A fallback Budget often covers fixed expenses and other necessities to keep the business a going concern.
It allows you to spend the bare minimum to cover immediate emergencies until the condition or circumstances improves.
8- Set Up a Lifeline
We expect the rainy-day fund to carry the business through turbulent times until it improves. However, what if the bad times last longer and the fund is depleted?
A business should have a lifeline to fall back on; otherwise, it risks shutting down. What is your lifeline strategy? It may include lines of credit or credit cards.
Note: You should only use these avenues as a last resort since they carry high-interest rates that may negatively impact your business in the future.
9- Celebrate Your Success
Saving for emergencies is a noble undertaking that requires discipline and sacrifice. It is only reasonable to reward yourself when you attain a significant milestone.
Rewarding yourself gives you the motivation to keep going. You undoubtedly need encouragement to keep building your dream business to the next level. Take yourself to dinner or have a fantastic haircut.
When you see the fruits of your hard work and discipline, the chances are you will go all the way.
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Benefits Of a Business Emergency Fund
Besides grounding your business during a crisis, an emergency fund has additional benefits. Consider some of them:
1- Security
The emergency fund offers you a measure of calm and security, allowing you to run your business without fear.
You need that measure of protection to take up risky but profitable ideas, unlike when you don’t have a fallback plan.
2- It Allows You To Pay Bills When Things Are Not Good
The sun will rise and set even if you are dealing with an emergency, so you will still have bills to pay.
If you rely on your business to help to pay expenses like rent, internet, electricity, accounting software subscription, or mortgage, the emergency fund may help you sort them.
3- It Saves Your Personal Savings
If you don’t have a business rainy-day fund, you may resort to savings to keep your business running. Your savings may not last long when you pay employees and handle other mandatory expenses.
However, with an emergency fund, your savings remain intact. You can continue living because you have money to sort your business situation.
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Final Thoughts
Every business needs a rainy-day fund because bad times will come. As an entrepreneur, you do not want to be caught unprepared by eventualities.
Building an emergency fund takes sacrifice and discipline, but it is worth it. Businesses that went through the Covid-19 pandemic can ascertain the value of an emergency fund. Failure to create this fund can sink your business in case of unfavorable economic changes, so prepare.