Sometimes, the company may need to lay off an employee or hire more workers to match the growing demand. In all these instances, some costs that are not expected have to be incurred. At such a time, an emergency reserve would be handy, reducing the shock on the business’s cash flow and financial planning.
Some people think that to help many entrepreneurs know how to set up an emergency fund, this is just a matter of setting aside a portion of their money. However, it is necessary to actually analyze your needs, including understanding your financial situation, and understand the emergencies which you may face.
In the text below, we will show you what an emergency fund is , its importance and how to set it up step by step. This way, your company will be prepared for any unforeseen event and will be able to bounce back. Just read, study and apply it with the right tools.
Have a good read!
Emergency reserve: what is it?
This is the sum an organization keeps for unforeseen events in its emergency fund.
As an example, let’s assume you are a bakery owner. You cannot wait till the end of the month to see whether you will have money left in your pocket to repair the oven. It’s the core operating asset for the business. No oven means no bread, and no bread means no bakery.
In this case, you should immediately call maintenance and have all the money saved for them. And where will this money come from? From the emergency fund. It is exactly as the name says: an amount set aside for emergency situations.
Now that you know when to use an emergency fund , it’s a good idea to learn when not to use it. This makes a difference in your business’s financial control . After all , many people confuse the fund with working capital, as both are amounts saved, but for different situations.
Working capital is an amount used to pay the company’s short-term bills. Restocking, salaries, office rent, etc. All of these expenses are expected. In fact, that’s the difference.
In short, working capital is an amount saved for expenses you expect to pay and the emergency reserve is an amount saved for unexpected expenses.
Why does every company need to have an emergency fund?
No company or person in this world is immune to unforeseen events. In recent decades, we have seen several of them. Pandemics, semiconductor crises, supply problems with this or that input: all of these affect any business.
A person may think that their bakery, to use the example from the previous topic, has nothing to do with international politics. However, the price of wheat is affected by the dollar. In other words , unforeseen events can come from anywhere and the emergency reserve needs to be on your financial control spreadsheet.
Discover below 5 crucial reasons to have a good emergency fund:
Have financial support in the event of unforeseen events
The first reason is to be prepared for unforeseen events in general. As we have already said, maintenance of a machine or an investment opportunity may arise. And in these moments, an emergency reserve will be necessary.
However, be careful. Your emergency fund cannot be your personal account. You must set aside this amount from your own business activity.
Having a financial reserve will give you more peace of mind when managing your company. With your account prepared for emergencies, there is less chance of administrative instability.
Avoid borrowing or excessive credit card use
Many entrepreneurs fail to build up an emergency fund, knowing that they can simply take out a loan or use a credit card. However, the interest and other debts will compromise their financial control.
It is tempting to re-invest all your money and to expand the business. But that’s what unforseen events are called: you never know what happens. Better to have a reserve rather than loans or credit cards, which means leading yourself into debt.
In short, by avoiding resorting to these extra resources, you protect the financial stability of the business and avoid compromising the future with additional bills. Investing in market reserves is a smart decision to deal with unforeseen events and ensure the financial stability of the company in the long term.
Not suffer as much from the impacts of market declines
The market is volatile, no matter what industry you’re in, so there will be times when sales will slow down. It’s a natural part of the economy. But you can’t afford to stop paying your bills because of it.
An emergency fund is also important here. These times affect everyone. However, if you are strategic, you can still use your emergency fund to find a solution that turns a downturn into an opportunity.
Ensure working capital
We mentioned earlier in this text that emergency reserve and working capital are different concepts. Just to remind you: working capital is for the company’s day-to-day expenses. Electricity bills, salaries, and inventory replenishment. The reserve, on the other hand, is for emergencies , as the name suggests.
But sometimes working capital is not enough. An employee’s contract termination or extra inventory replenishment are unforeseen events. The emergency reserve can cover this deficit in working capital.
Be able to plan better
The feeling of being able to manage your company with peace of mind and stability is great. Having an emergency fund allows you to plan with more confidence. After all, if something goes wrong, you have a plan B.
And we mean all aspects. Administrative, creative, operational, marketing… The emergency reserve allows you to plan better and even reduce costs without fearing the negative impacts of this.
Step by step: how to structure your company’s emergency fund
Now, let’s break down step by step how to save an emergency fund. Most people think the correct way is to simply set aside a percentage each month. We won’t lie; it’s better than saving nothing. However, there are smarter ways of organizing this financial movement.
Check out the steps below:
1. Analyze your finances and make a financial plan
Calculating the amount to be saved involves knowing how much you earn and pay during the month – in practice, it means having complete clarity about your accounts payable and receivable. Financial planning is the basis for any money movement, which includes the emergency reserve .
2. Reduce costs and optimize expenses
Once you know how much money you have on hand, what you spend and what you earn, think about increasing your revenue. To do this, identify smart ways to reduce your company’s costs and optimize expenses. You can make these savings on several fronts.
For example, some accounts may offer discounts when paid in advance. And upgrading your processes, machines, and systems can make your operation more profitable, leading to a lower cost per sale . But of course, don’t make cuts that could harm your operation.
3. Set the amount to be saved and make adjustments when necessary
With your finances clear and organized, with reduced costs and a greater understanding of your company’s financial reality, it’s time to define how much your emergency reserve should be.
The basic principle of calculating your emergency fund is to think about your goal. Experts recommend that you set aside 6 to 12 times the amount you spend each month . Of course, you’re unlikely to reach that amount in just one month — so set aside a percentage that won’t hurt your finances, but know what your goal is. It’s also important to be consistent. It’s better to save $10 every month than to set aside $200 but never save it.
4. Consider investing your emergency fund
Stale assets are depreciated assets. The money in your emergency fund should be invested so that it yields more. This way, the amount will become larger. However, avoid risky investments .
To find out where to invest your emergency fund, look for reliable banking institutions and request a very conservative investment . Preferably, one with high liquidity – so that you can withdraw the amount in emergencies without incurring losses.
What ultimately matters is having good business financial planning. This way, you not only ensure your emergency fund but also prevent it from being used too often. Financial organization is a company’s main asset.