Sarah George
·6 min read
Part of maintaining a balanced business budget is having a business emergency fund. Not only can it help businesses push through an uncertain economy, but it can also protect a business from financial challenges or unexpected expenses.
According to the Federal Reserve Banks’ 2022 Small Business Credit Survey, 94 percent of employer firms experienced a financial challenge within the previous 12 months. Of those, 81 percent cited the rising cost of goods, services or wages as their primary financial concern.
Businesses aren’t the only ones feeling the economic strain. Bankrate’s annual emergency savings report found that 63 percent of U.S. adults say inflation is causing them to save less money for unexpected expenses.
As many business owners invest personal funds into their businesses, a lack of savings can create personal and professional financial challenges, making a business emergency fund essential to a small business’s survival.
Key insights
81 percent of Americans didn’t increase their emergency savings in 2023, with 60 percent of Americans feeling behind in this area. (Bankrate)
53 percent of small business owners reported using personal funds in response to business financial challenges in 2022. (Federal Reserve Banks)
63 percent of Americans do not think their personal financial situations will improve in 2024. (Bankrate)
In Q4 of 2023, 50 percent of small businesses cited inflation as one of their biggest challenges. (Small Business Index)
What is a small business emergency fund?
A small business emergency fund — sometimes called a contingency fund — is a stash of savings that a business draws from during an emergency or financial challenge. Ideally, a business emergency fund should be separate from a business checking or savings account. Examples of the expenses your emergency fund should cover are:
Rent or commercial mortgage payments
Utility bills
Inventory and raw materials
Business website and related costs, especially if your business is involved in e-commerce
Employee payroll and benefits
Debt repayments
Why start a business emergency fund?
Every business needs an emergency fund for the unexpected, such as a downturn in the market, emergency equipment repairs or operational expenses.
Bankrate’s annual emergency savings report found that 66 percent of U.S. adults would be worried about having enough emergency savings to cover living expenses for the next month if they lose their primary source of income. Further, 22 percent of U.S. adults said they have no emergency savings.
Saving for emergencies can help reduce worry and stress for business owners. Here’s how an emergency fund can help your small business remain financially resilisent:
Protection against emergencies
As the name implies, a business emergency fund should help your business cover emergencies that arise. As an emergency is unexpected, it’s difficult to plan for in your business budget unless you keep an emergency fund.
Types of emergencies that can impact a small business include:
Natural disasters
Economic downturn or recession
Pandemics
Legal issues
Break-ins or theft
Damage to commercial equipment or property
Protection for assets and more stability
Emergency funds can help protect your business and personal assets. For example, if you have taken out a business loan, you may have signed a personal guarantee. Or you may have backed the loan by putting up business assets as collateral.
If you miss multiple payments or default on the loan, the lender could come after your business and personal assets to repay it. Your business and personal credit history can also take a hit if you miss payments due to a lack of funds. An emergency fund can help prevent that.
Easier cash flow management
Not having a business emergency fund can compare to living paycheck to paycheck. With an emergency fund, you can weather the economic ups and downs without putting additional strain on your business or personal finances. If your revenue comes in lower or an emergency crops up, you have the funds to cover operational expenses and keep your business running.
Less dependent on debt financing
Some business owners use a small business loan to help them through unexpected expenses or months of low revenue to cover operations.
While there isn’t anything wrong with having a business credit card or business loan that you responsibly manage, a business emergency fund means you’re less reliant on debt financing to cover emergencies. This can be beneficial in the long run, as using debt financing to cover emergencies can easily spiral out of control if your business can’t manage the repayments.
Assistance with time-sensitive business opportunities and growth
If you come across an unexpected opportunity or gap in the market, your emergency savings can allow you to take advantage of it. For example, you could use your emergency funds to produce or offer a new product or service you otherwise wouldn’t have the capital for. It can also keep you from going into debt to get the product or service to market.
Keep in mind:Using your emergency fund for business opportunities can be risky, so be sure to weigh the pros and cons before moving forward.
Bottom line
An emergency fund helps a business remain resilient despite any challenges it may face. Your business emergency fund can help with new opportunities, cover unexpected costs and protect your assets. As a rule, you want to save several months’ worth of expenses in your business emergency fund. While saving a sizable percentage of revenue is recommended, saving any amount for emergencies is a step in the right direction.
Frequently asked questions
How do I create an emergency fund for my business?
You can create an emergency fund for your business by putting money in a separate business checking or savings account. A good starting point is saving 10 percent of your business’s monthly revenue, but you may want to adjust this number based on your business’s cash flow.
Is $5,000 enough for an emergency fund?
An emergency fund of $5,000 is likely not enough for a business or personal emergency fund, though it depends on expenses. The best way to determine how much you need for an emergency fund is to calculate your monthly expenses and multiply that number by at least three. Ideally, you want enough in your emergency fund to cover three to six months of expenses.
Is an emergency fund the same as a business savings account?
While a business emergency fund is a type of business savings, it is typically separate from a business’s other savings accounts. An emergency fund is any business account that you use to save money specifically for emergencies. It sometimes may also be referred to as cash reserves. But your business may have other savings or accounts that it uses, such as a savings account for operating profits.
As an expert in financial management and small business operations, I have extensively studied and advised on the importance of maintaining balanced budgets, establishing emergency funds, and navigating financial challenges in both personal and professional contexts. Let's delve into the concepts and insights presented in Sarah George's article, highlighting key elements and providing additional context:
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Business Emergency Fund:
- A business emergency fund, also known as a contingency fund, serves as a reserve of savings specifically allocated to address unforeseen financial challenges or emergencies within a business.
- It should ideally be distinct from regular business accounts like checking or savings, ensuring clear separation and earmarking of funds for emergencies.
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Rationale Behind Emergency Funds:
- Businesses encounter various unexpected expenses or downturns, including rising costs of goods, economic recessions, or sudden equipment repairs.
- Personal funds are often injected into businesses to mitigate financial challenges, underlining the importance of having a dedicated emergency fund.
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Statistics and Insights:
- The Federal Reserve Banks' 2022 Small Business Credit Survey indicates that a significant majority (94%) of employer firms faced financial challenges in the preceding year, with rising costs being the primary concern for 81% of them.
- Bankrate's findings reveal that 63% of U.S. adults are saving less due to inflation, with 22% having no emergency savings, emphasizing the broader impact of economic factors on personal financial resilience.
- Notably, 53% of small business owners resorted to personal funds to address financial challenges in 2022.
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Types of Expenses Covered:
- An emergency fund should encompass various operational expenses such as rent, utilities, inventory, payroll, and debt repayments.
- It serves as a buffer against disruptions caused by natural disasters, legal issues, theft, or economic downturns, safeguarding both business and personal assets.
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Benefits of Establishing Emergency Funds:
- Mitigating financial stress: Having an emergency fund reduces worry and stress associated with unforeseen expenses or income loss.
- Ensuring cash flow stability: Businesses can navigate economic fluctuations without resorting to debt financing or risking operational disruptions.
- Facilitating growth opportunities: Emergency funds provide flexibility to seize unexpected business prospects or invest in expansion without incurring excessive debt.
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Fund Management and Recommendations:
- Experts recommend saving several months' worth of expenses in an emergency fund, typically ranging from three to six months.
- Establishing a systematic savings strategy, such as allocating a percentage of monthly revenue, helps build and maintain adequate reserves.
- Assessing individual business needs and expenses is crucial for determining the optimal size of an emergency fund.
In conclusion, cultivating financial resilience through the establishment of robust emergency funds is paramount for small businesses to navigate uncertainties and sustain long-term growth. By proactively allocating resources and adhering to sound financial practices, businesses can mitigate risks and seize opportunities amidst evolving economic landscapes.
