Most business owners do not consider emergency funds to be important. Research has shown that 20% of small business owners believe that their number one challenge in the start-up world is the lack of adequate amount of cash to keep things going. These monetary issues could be tied to limited sales, piling debts, mismanagement of capital, etc. However, it could just be not having a little bit of cash to fall back on when things hit the fan.
This is why having an emergency fund is crucial for SME owners. When the days get tough, and it seems harder to pull through, some cash in hand could go a long way. In periods with lockdowns and shutdowns, the importance of emergency funds cannot be overestimated. Knowing that the world of business is unpredictable and life could take a wide range of turns for better or for worse, an emergency fund could be the difference between a business that survived and one that crashed along the way.
What are Emergency Funds?
Emergency Funds refer to liquid savings accounts created specifically for emergencies, as the name implies. The funds contained in this account cannot be used for a company’s daily operations but can only be used when there’s an urgent emergency to attend to.
Usually, businesses make use of emergency funds whenever they notice a revenue downturn or in times of an economic crisis, such as recessions. The issues could also be around losing a major customer/ client, drastic changes in the industry or even a lawsuit. No matter what it is, the idea is that emergency funds come in handy to keep the business afloat in other dire situations.
Advantages of Having an Emergency Fund for your SME
Risk reduction
With an emergency fund, you can easily mitigate some of the risks you encounter over the course of running your business. You wouldn’t have to set yourself up for unnecessary risks or hazards because an emergency fund automatically reduces the chances of you being largely derailed by unfavourable surprises. Unexpected issues can come up now and then on the business’s management or founders and even the business itself.
This could be from a sudden illness, a decline in the interest of the product in the market, or a decline in the industry as a whole. An emergency fund is what ensures that your business bounces back no matter what you might have encountered. It is synonymous with a shock absorber as it protects you and your business from being too shaken by unexpected circumstances.
Avoid Issues with Credit and Late Fees
With an emergency fund, you won’t need to depend on costly credits to meet short term obligations; neither would you have to incur late fees. Emergency funds help you meet up with issues such as bills, operating expenses, and payrolls. Basically, it saves your business from embarrassments and helps you meet up your promises, especially finances.
No Need for Personal Funds
You won’t have to use your personal funds or payout of your business’s working capital to mitigate risks and solve challenges that come surprisingly. An emergency fund creates a funded account for those surprises so that even when they come as they often do, you will still have your balance. Many businesses fail because business owners use personal funds to curb revenue losses and other changing needs. Spending out of pocket for business needs is certainly not sustainable.
On Determining the Size of Your Emergency Fund
Several experts have varying opinions on how much you should keep in reserves. Still, the most important thing to take into consideration is your cost of operation in addition to other factors that majorly affect your business. Your receivables and inventory are important factors crucial to the size of your emergency fund.
For businesses whose receivable turnover periods are high, it is always advisable to keep enough cash in the works, so you are not always anticipating monies your business depends on for survival.
Businesses with goods or products which generally sell in seasons or cycles are typically advised to have more in their emergency funds, as their businesses are more volatile and subject to high risks. You can have an emergency fund by allocating a certain portion of your revenue to that account on a scheduled and regular basis. Also, you wouldn’t want to put all your funds in the emergency fund account, which would hinder smooth business operations. However, a small amount every month will go a long way in difficult periods.