Setting Up an Emergency Fund in Your Small Business

As small business owners, we can get so caught up in the day-to-day that we can forget to look at the bigger picture of how we are running our businesses. When we do this, it often comes at the expense of future growth and stability.

One major area that quickly turns into a stumbling block for many small business owners is being prepared for an emergency, and the most basic element of this preparation is having an easily accessible emergency fund. The following are the most common questions small business owners ask when it comes to putting aside money for a rainy day.

Where Do You Get the Money for Your Emergency Funds?

Business owners may have up to five possibilities for setting aside and accessing emergency funds. Keep in mind that I'm only talking about sources of money that stem from the business' own assets. That is the most frugal, and safest approach.

- A business line of credit.

In an ideal world, most business owners would be able to go to their local bank and set up a revolving line of credit to help them smooth out their cash flow and to act as a buffer should a sudden cash shortfall occur. But the truth is these days that banks are still being a bit reluctant in offering credit to many small businesses. If you are one of the few with stellar credit and a solid business model than it pays to get a line of credit set up. Alternatively, you could get a low interest business credit card and use it for occasional charges just to keep the account open in case you need to use it for some future cash emergency.

- Put money aside.

Put aside a small portion of your monthly revenues- we're talking 5% to 10%. Think of it as an emergency tax. To make sure you actually put this money aside instead of spending it on your business, you can set up a payroll deduction or have withdrawals automatically sent to a separate business savings account.

- Use your tax refund.

Another possible option is to send either all or a significant portion of your tax return into your emergency fund. Though it may not be enough to fully fund the account, it can at least give the your emergency funds a boost.

- A sudden cash windfall.

If you happen to have an exceptionally strong period of sales, then think ahead and dedicate a portion of this money to your emergency account. Like the tax return above, you may not necessarily fund the whole account at this time, but you can get much closer to your goal.

- Asset-based financing.

Though not an emergency account, in certain cases it could be used as an emergency fund backup, such as when not enough money was put aside. Asset-based financing arrangements like accounts receivables factoring, business cash advances, and revenue based financing all have the benefit of being quick and "easy" sources of capital. Just expect to pay a premium for the service, something to the tune of 25% to 30% of the amount funded.

Where Should You Put Your Emergency Fund?

There are two primary factors you have to consider when determining where to stash your emergency cash: 1. How liquid is set up?; and 2. How much do you stand to earn from the money while it's not being used?

Realize that the cash in an emergency fund needs to be liquid. This means that it is easily accessible to you when you need it without cost, delay, risk, or penalty. Now, the most liquid accounts are banking products like checking and savings accounts and money markets. But depending on how much you need to put aside, you'll be earning less than peanuts in interest the whole time that money sits there.

That's also not good. You don't want to be using your primary business bank account for emergencies even if you have overdraft protection because you could be losing any money that you could generate in more interest bearing set ups.

So, what you need to do is create some kind of combination of products that will give you the liquidity you need while giving you the best possible return on your funds. One possibility: keeping two months worth of expenses in a "high interest" online bank account (preferable one that offers a debit card and/or checks) and putting the rest in a series of short-term certificates of deposit (CDs) that are "laddered" so they mature at different times.

How Much Money Should You Be Putting Aside?

While there is no definitive number for how much money you need to be putting aside, most people agree it should be somewhere between three to nine months of your basic fixed expenses. This means things like payroll, mortgage, rent, insurance premiums, utilities, and transportation. Keep in mind that you should consider both the needs of the business as well as your own personal needs especially if your business is your primary source of income.

Depending on your industry, you may also need to do a risk assessment. If, for example, there is a high risk of being sued by a customer or losing your inventory to a natural disaster, then this has to be taken into consideration, and it should be discussed with a qualified financial adviser who is familiar with your particular industry.

Is an Emergency Fund Really Enough?

In an earlier post, I laid out some of the basic elements of disaster planning. Having a suitable emergency fund is just one aspect of this process. Where applicable you should also make sure that you are familiar with any federal or state loans that may be available to you, such as the Federal Emergency Management Agency (FEMA), and the SBA backed disaster loan program. You may also want to consider various business insurance policies.

In short, when life throws you a curve ball, you don't want to be caught off guard. A little planning can help smooth out some of the biggest bumps along the way.