When you’re beginning a new business, you’re usually full of optimism and drive. Within the first couple of years, however, you tend to run into obstacles and setbacks that can lead to its early failure. An analysis on Forbes focusing on why entrepreneurs fail, identified the top reasons. For one, 42 percent of failures were attributed to a lack of market demand. For a product or service to be successful, it needs to address a gap or need in a market, and if it doesn’t, then you’re in trouble. The second reason behind 29 percent of closures was due to being short on cash. Initial costs like buying website domains, hosting, and creating business cards can quickly run up costs beyond your best predictions. From this, it’s clear that an emergency fund is crucial to prepare for any unforeseen costs that could lead to the early downfall of your business.
Why do you need an emergency fund for your small business?
1. To have immediate monetary access in times of crisis
Sometimes, it can be difficult to see where your money goes. In our article ‘Managing Cash Flow and Beyond’, we discussed the importance of setting money aside for sales tax, fixed costs, and inventory. However, even if you do have enough money to cover everyday costs, unforeseen events can pop up. Theft, property damage, or key equipment breaking down means that you might need to cover these costs immediately. Even if you do have insurance, processing these claims can take a great deal of time and effort. That’s why an emergency fund can provide you with the cash you need to cover costs during times of crisis.
2. To be able to quickly capitalize on trends
Another factor has to do with your ability to act quickly when it comes to new trends and staying competitive. Entrepreneur suggests being the first to move when you see an opportunity so that you can capture the loyalty of customers immediately and maximize your profits. Of course, due diligence and some cautiousness is still called for. The US Chamber of Commerce also suggests that having enough funds can enable you to “buy out a competitor or purchase extra inventory at rock bottom prices”, and act with decisive speed.
3. To sustain your business during slow periods
Having an emergency fund can help carry you through slower cycles, especially if you deal with a seasonal product, like swimwear. Swimwear, for instance, tends to sell best in the summer, with sales seeing a massive decline in the colder months. However, you’ll still need to pay the costs required for upkeep, so it’s always best to have a good sum set aside for this eventuality.
How much do you need to save for an emergency fund?
Much like a personal emergency fund, small businesses should cover at least three months’ to a year’s worth of expenses. A Marcus guide on how to build an emergency fund notes that figuring out how much you need starts by understanding how much you spend on a regular basis. This involves the essentials, such as employee salaries and maintenance costs. Obviously, the exact amount will depend on a business’s unique circumstances. A growing medical practice or a financial firm would probably need a much larger fund compared to someone operating a small retail store online. The former two fields are probably more vulnerable to lawsuits than the latter, so it’s always better to be safe than sorry.
How can you build your emergency fund?
Attempting to build your fund from scratch may sound daunting when combined with all your other expenses, but it’s a lot easier than you think to build up a healthy amount. All it takes is some know-how, a large amount of willpower and the ability to properly organize your assets. Here are some tips to get you can get started on building your fund:
1. Save in times of plenty
When your business is doing great, it can be tempting to spend that money on upgrades or business trips to treat your employees. However, now’s the best time to add any spare cash to your emergency fund.
2. Keep it in a separate account
One major misstep that many businesses make is accidentally spending your emergency fund on day-to-day things. To prevent you from being tempted, it’s best to keep the fund in a different account from your personal and business expenses, so you can keep accurate tabs on its growth.
3. Put it somewhere where it can grow (but you can still access)
Small Business Trends recommends looking for instant access savings accounts to help your fund grow. The key thing is to put it somewhere that generates interest but remains liquid and easily available for you to access. While you should avoid putting it into the stock market, money market funds or short-term Certificates of Deposit are some good options. Make sure to do your research to find which options offer you the highest interest rates.
4. View the fund as a non-negotiable concept
It can be difficult to grow your fund if you’re constantly making impulse purchases for your business, taking business trips, or having meetings at fancy restaurants. To avoid this, try to imagine a scenario where you’re having an emergency without being financially prepared — or simply think of it as a business expense. This way, you’ll get into the proper mindset for adding to your savings.
In the end, having an emergency fund should be a huge priority for your small business. If you want to see it expand and thrive in the future, having a safety net to deal with unexpected expenses will save you from further stress and hassle in the long run. All you need is some planning and dedication to start building up your fund, which will eventually come to reap massive rewards.
Feature article for retailcloud.com
Written by Emily Sanders