Right from starting a business to running it smoothly and putting it on growth track, every entrepreneur plans everything very well in his own capacity. However, even most successful businesses sometimes encounter challenges that are beyond their control. Let it be some sort of natural disaster, equipment breakdown, employee illness/injury or unstable economy, a small business or a startup can suffer financial emergencies of all shapes and sizes.
So, a small business must be prepared for all such financial emergencies and creating an “Emergency Fund” is the way to go. You must always plan ahead; it is important to have a contingency plan for all types of financial emergencies and to do so, you must be aware of all the available options.
This article will discuss step by step procedure to plan and create emergency funding plan for your small business, using all possible options.
Step 1: Do a Risk Assessment
The first thing you need to do is to know how much risk is involved. The actual size of your emergency fund may vary depending upon your industry and nature of risks involved. For instance if there’s a high risk of being sued by a customer, or your industry is heavily regulated by government, you may need to get help of an efficient business analyst to figure out the numbers.
But if you’re operating a relatively low-risk business, three to six months of cash in an emergency fund is great to go.
Step 2: Manage the Cash in Hand Wisely
An enormous emergency fund will not be enough if your cash flow is poorly managed. Manage expenses carefully, improve receivables by asking customers to accelerate payments and make sure that you pay your employees first, because unpaid employees will soon be ex-employees.
Step 3: Create an Emergency Fund from Existing Resources
You are moving to this step when you’ve already taken the steps to reduce spending and accelerate sales revenues. The next step is to increase the amount you’re putting in your virtual piggy bank each month. This is how you might want to go:
1- Save in high-profit times, i.e. during the high-earning months.
2- Invest that amount in assets/investments which can be liquidated faster during the rainy days.
Doing this manually is fine to go, but a much better way is to opt for an automatic savings plan that deducts money from your checking account before you can use it for other stuff.
Step 4: Have Short Term Loans in the Plan
Short term loans can be life saving for startups and small businesses during the times of financial emergency, however, you need to plan ahead and have all the options in mind when you actually need them. Here are some most popular and highly useful short term loan sources that you must have in your plan:
1- Friends and family: They tend to offer lower interest rates and flexible repayment terms.
2- Local payday loan store: You can apply online and get money right in your bank account the same day or in couple of days. Not much documentation is involved, and the process is completely hassle free.
3- Using your credit card can work great in times of short term financial emergencies.
4- Personal loans: Particularly a sole proprietorship or a small business partnership might be able to secure a short-term emergency business loan by having the owner draw on a personal line of credit.
5- SBA loans: In the US, the Small Business Administration coordinates short-term emergency business loans for qualified business owners. Do check if you qualify!
Step 5: Know these Important DOs and DONTs of Emergency Loans
It’s not just about filling your emergency fund with money; you must make smart choices, based on the prevailing market conditions and situations. Here are some DOs and DONTs to consider:
- Avoid withdrawing money from your home equity or personal retirement accounts.
- Do find the best interest rate.
- Do read the fine print, and know the red flags and repayment penalties.
- Do pay on time, every time.
- Always remember that borrowed money is not free.
- Don’t borrow carefree!
- Don’t borrow more than you can afford.
- If you’re having trouble in understanding or keeping up with the borrowings, do seek help of an expert.
Step 6: Raising Funds by Leasing & Selling Assets
In most of the cases, business savings and emergency loans can handle the situation well, but at times the financial emergency may go beyond the expected time frame. In that case, you can also raise cash by selling and leasing back assets such as machinery, equipment, computers, phone systems and even office furniture.
Well, it’s not cheap, and you must know that you could lose your assets if you miss lease payments.
The Bottom Line
Creating an emergency fund for your small business is all about making the right choices at right time, i.e. saving at the peak periods, turning your savings into safe investment that can be cashed out with little notice. Moreover, study the available funding options and keep the best ones in plan.