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Why You Need a Small Business Emergency Fund
Most businesses experience an occasional cash shortage, but when your business is short on cash, you need a strategy to ride it out. For most companies, an emergency fund is part of that strategy.
Unfortunately, many businesses don't have an emergency fund. In 2019, the market intelligence company CB Insights analyzed 101 failed startups to discover why these companies failed. Running out of cash1 was the second most common reason, impacting 29% of failed ventures.
Clearly, cash reserves aren't just nice to have -- they're a matter of survival. Here are five reasons why you and your business will benefit from a business emergency fund.
To cover unexpected emergencies
Fire, flooding, hurricanes, tornadoes, wildfires, and other disasters threaten businesses every day. While you may have insurance to cover property damage or business interruption, it takes time to process a claim. Having cash on hand ensures that you can get back to business quickly after a disaster.
An emergency fund bridges the gap between disaster and insurance protection so you can start making repairs and rebuilding immediately. This is why a solid emergency fund should be a critical part of your business continuity plan.
Recessions happen about every 4.7 years in the U.S.2 It's a lot easier to cover payroll, order supplies, and pay rent if you have an emergency fund.
To prepare for economic downturns
Historically, recessions happen about every 4.7 years in the U.S.2 and can last anywhere from a few months to a few years. We never know when they will arrive, which industries will be hardest hit, or how long they will last.
Being able to cover payroll, order supplies, and pay rent during a recession is a lot easier if you have at least several months of expenses set aside.
To protect your business credit
When unexpected expenses or emergencies come up, many businesses rely on credit to stay afloat. Credit cards, loans, and credit lines are useful tools for helping companies cover unexpected expenses in the short term. But missing a credit card or loan payment can damage your business credit score. This can negatively impact your ability to qualify for more credit in the future, which can ultimately hurt your business in the long run.
An emergency fund can ensure you have the cash available to pay your bills on time, one of the most important factors in maintaining your business credit score.
To protect your personal assets and credit
When your company needs money to make payroll or cover other day-to-day expenses, do you put your personal money into the business? If you have the funds or credit available, it's easy to do.
However, using your personal assets as an emergency fund is risky. If the business folds, you lose those assets. If you took out a personal loan or used a personal credit card to cover business expenses, it can also damage your credit -- even if you are able to eventually pay off the debt.
To take advantage of new opportunities
A business emergency fund should always be on hand for true emergencies, but having savings available can also open positive doors for your company when time-sensitive opportunities arise.
Having cash available can allow you to expand your business, purchase equipment from a competitor that is going out of business, strategically launch a new product, or purchase extra inventory at bargain prices. The extra cash will give you the flexibility to move quickly when you see potential.
Important disclosure information
This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.