Small businesses don’t typically have tons of cash to leave on the sidelines. Still, even without a nation-wide shut down, the Bureau of Labor Statistics has reported that approximately one-third of businesses fail within the first two years, and half don’t make it past five years. About 82 percent of these failures point to cash-flow issues.
You’ve heard about the importance of emergency funds for individuals, and they’re equally important for small businesses. Maintaining such a fund is not typically easy, but if you understand the underlying reasons and apply a disciplined approach toward building a fund, your business can be healthier and better-able to roll through economic ebbs and flows.
Likely Uses for Emergency Funds
Having extra cash on hand can serve many purposes, such as the following:
- Meeting real emergencies: This is why they’re called “emergency funds.” Just make sure that you understand what a true emergency really is. A good rule of thumb might be to dig into your fund when the money buys you the time you need to avoid financial ruin so you can get back on track. For example, extra cash on hand might get your business through a temporary financial downturn in your industry.
- Taking advantage of sudden opportunities: Is your entire team of software programmers operating on outdated computers? Just think of what it would mean if you had the money to take advantage of a 50 percent off sale on top-name computers. Anytime you can modernize equipment at low prices to keep up with customer demand, you can think about spending some of your emergency savings – as long as you don’t wipe out the entire fund.
- Staying afloat during seasonal slow-downs: Even if you sell ice, you still face fixed costs during the winter months. Extra money in the bank will help you to pay those costs. In fact, that cash might make it possible to expand your business with products that sell well during the off times.
- Adding to your staff: You probably should not consider using fund money to hire more full-time employees. But, temporary or contractors might be an option, provided that you understand the differences. Putting some of your savings into this type of hiring might pay back significantly in increased production and sales.
- Being prepared for tax time: Hopefully, your accountant keeps you apprised of any additional money that you might owe in April. If there are surprises, however, dipping into your emergency fund is an option, even though it’s probably not your first choice.
Of course, these and other spending options have one important thing in common: you need to pay the money back. These payments should be over and above the money that you already conscientiously save on a regular basis.
Use Discipline to Build Your Fund
Discipline starts by knowing your numbers well enough to recognize how much money you need to keep your business running over at least several months. Once you know that, it’s a matter of figuring out how to build your fund, even if it’s just pennies at a time.
Perhaps the best way to get started is to allocate some portion of income that you transfer to a separate account at your bank. Make that allocation automatic, much as a 401-K plan allocates paycheck funds for employees.
You can also take advantage of good times. When sales are higher than usual, see at least part of that extra income as an opportunity for savings, rather than just a way to buy new paintings for your office walls.
Smart individuals look toward their futures by finding creative ways to save their money now. You should certainly do the same for your business.
Set Rules for Spending Money From the Fund
Discipline applies to spending, too. While you’re planning ways to save money, be sure to devote serious time to defining what “emergency” really means.
As a general rule, real emergencies are events that entirely prevent you from conducting business. The full break-down of a critical piece of equipment might be one example.
Similarly, situations that keep you from fully-supporting existing and new customers might qualify as emergencies. So, if you need to pay for warehouse expansion that allows you to stock the products that your customers demand, devoting part of your emergency fund to pay for the extra space can make sense. In fact, the extra money that you make can help to replenish the funds that you used to pay for the expansion.
Of course, when setting rules for emergency spending, you should also determine how and when you will pay it back. Consider any money taken from your emergency fund to be a loan rather than a gift. You’re bound to face new emergencies in the future, and you can’t afford nasty surprises when they inevitably happen.
An Emergency Fund is a Vital Component of a Good Plan
You’ve seen many examples of companies that survived the shutdown very well by turning their talents toward making new products, from face masks and hand sanitizer to ventilators. Others changed their sales model by including curbside pickup or even selling online for the first time.
Emergency funds can be essential toward funding changes like these. But, they’re also vital toward basic survival during challenging times. Whether your fund helps you to pay employees longer, or even if it helps to pay rent and feed your family, it’s much more than just money sitting on the sidelines.
I think that Brigham Young summed it up well when he said, “A fool can earn money; but it takes a wise man to save and dispose of it to his own advantage.”