The lack of adequate funds has always been a very troublesome factor for small businesses trying to survive and grow. At a time, when the economic climate is especially turbulent, a small business can easily turn turtle due to the lack of an adequate cash reserve, observes Eric J Dalius, a renowned small business consultant. Typically, businesses use emergency funds to survive during economic disruptions, however, they are also vital to keep the business going through other crises like losing a very large customer, regulatory issues, or even a crippling lawsuit.
The Pros and Cons of Setting up a Business Emergency Fund
An emergency fund can help the business to protect its operations from being impacted by unforeseen issues like a market recession, lack of demand, illness of the owner or a key employee, etc. Important payments like wages, utility payments, taxes, etc. can still be met from the emergency fund. Having a cash reserve also means that you will not need to dip into your personal savings to keep your business going. Further, you will be able to pay your bills on time and not incur steep late payment penalties by the card companies or a huge amount as interest for rolling over your balance. By making timely your payments, you will be able to protect your credit score from being damaged, observes Eric Dalius.
However, the need to build a sizeable reserve fund can also limit the amount you can plow into your business, especially when a lack of funds is holding up business growth. Also, because you need to have liquid funds, the returns will be low as interest rates on bank savings account are not high.
Determining the Emergency Fund Size Is Important, Says EJ Dalius
Though there are different opinions regarding how large your emergency reserve should be, a prudent approach would be to peg it to your cost of operations and other factors affecting your business, like inventory levels and the level of receivables. Businesses that offer long credit periods or have to carry more inventory will need to keep the cash reserve larger. Similarly, you will need to consider the size of your payroll and think of the consequences of not being able to afford to pay your employees due to the lack of cash. Your financial status is also important because if you need the business to generate the money for your survival, the cash reserve will have to be larger than if the business was just something you did on the side. Businesses that experience revenue dips due to their cyclical or seasonal nature need even more emergency funds due to the additional volatility.
Conclusion
The best time to think about creating an emergency fund is when things are good and look to be even better in the future. Set aside some of the extra cash available during this time for an emergency reserve that will see your business through during the bad times. You can decide the ideal amount based on your overheads and operational costs per month. A reserve equivalent to three to six months of expenses is what you should target.
