According to a study by Insureon, 40% of small businesses don’t have insurance, but over 1 out of every 3 small businesses had a significant event, or hazard, that led to a sizable financial loss. Even some small businesses that were insured could not manage the long term financial strain of dealing with paying for these events. This is why having a business emergency fund can be important to the survival and future of your business.
While the right insurance might help with many situations, it’s impossible to know what types of insurance you will need for every potential business hazard. If you have the wrong one then the insurance company won’t pay out when the problem comes.
It can also be costly to maintain too many different types of insurance. Most small businesses don’t typically have enough cash flow to maximize their expenses by taking on extra insurance costs to protect against anything that could possibly happen.
Keep a Cash Cushion to Ride Out Disaster
Whether there is a large disaster, a slump in sales, or an overall economic downturn, having a cash cushion on hand can be the difference for your business staying open. In business lingo we are discussing retained earnings. You know, the kind of cash that Apple has just lying around to the tune of almost $250 billion. A cash cushion doesn’t need to be that big, but it should be sizable enough to sustain a business for a minimum of 3 months of all sales stopped coming in tomorrow.
For example, if your monthly business expenses are $10,000 then you need to have a minimum of $30,000 in your business emergency fund at all times. This is money that you don’t borrow from at all. It is strictly there to protect the sustainability of your business in times of need. If you have to use your emergency funds then you should work to replenish those funds as quickly as possible when you are able to again.
It isn’t likely that your sales will just completely dry up all at once. This means that a 3 month operating cash cushion will actually keep you going for a longer period of time, often as long as 6-8 months. The actual time will vary by business, but it should be long enough to help you determine how to move forward and solve whatever problem has come up.
This is also an amount that will be large enough to settle most disasters that might come your way, unless you find yourself in a really bad situation like a large multi-million dollar product liability lawsuit. Those types of disasters are what you should probably carry insurance for. The other smaller issues that may come up and cost you money should be covered by your emergency fund.
Insurance is Time Consuming to Deal With
Another reason that you want to have a business emergency fund is because filing an insurance claim and actually getting paid on it can be very time consuming. We spoke to a small business owner in Oklahoma that operates in the manufacturing industry. They preferred to remain anonymous, but their plant had a huge fire and everything was destroyed a few years ago.
It took nearly 1 year and thousands of dollars to fight the insurance company to get them to pay the business for the fire claim. Eventually the business felt forced to accept a settlement from the insurance company that was not only thousands of dollars less than the business was owed, but it didn’t fully cover what was lost in the fire.
The business was out of operation for months, and it cost the company consistent sales that they will never likely get back. It has been a huge burden for this small business owner, as his personal assets were tied to the business through an SBA loan. This burden of collecting from the insurance company, which the business owner felt like he was protected against, crippled the business. They are yet to return to pre-fire sales, and continue to struggle to keep the doors open on a daily basis. He could lose everything personally if the business doesn’t make it.
How to Start a Business Emergency Fund
As a small business you shouldn’t expect to be able to save the whole emergency fund amount up front. If you have those levels of retained earnings then you likely don’t to need to worry about an emergency fund.
Starting a business emergency fund is a lot like starting a business. You have to budget wisely, and often go without all of the “extras” in order to make the business or the fund more successful. Setting aside the largest amount you can on a monthly basis is a good start to get the fund off the ground.
Once you have your total fund amount saved then we recommend lowering your monthly contributions, but continuing to add to the fund as your business moves forward. You may need to lower the fund contributions to pay for additional expenses or to focus on your products. This is okay, but you should always keep the commitment. You never know when you will need it, and the more cash you have available the stronger your security will feel.
The Smart Hack
A business emergency fund can help strengthen the financial stability of your business, and give you the peace of mind to know you can deal with any hazard that may come up. Dealing with insurance is a necessity, but all insurances may not benefit you. The insurance company can be troublesome, time consuming, and costly to get a fraction of what should be owed to you in the event of a hazard.
Borrowing money to deal with a financial hazard can put your business in a worse financial position. Your business emergency fund should be grown as quickly as possible without hurting the operations of your business by contributing a set amount to it each week. No amount is too little, and you should save a minimum of 3 months worth of expenses.