Why Your Small Business Needs a Savings Account and an Emergency Fund
Did you know 20% of businesses fail in their first year, according to the Small Business Administration? And running out of cash is the most common reason for startup failure, according to a CB Insights study.
Saving money isn’t simply a nice or responsible thing for a small business. Saving money could make or break your business.
For most business owners, it’s important to save money for two reasons:
- Unpredictable expenses
- Predictable expenses
What is an unpredictable expense?
An unpredictable expense is an unexpected emergency expense that you couldn’t have foreseen. The cash to cover these expenses will come from your emergency fund.
The pandemic has proven that life throws some serious curveballs. Within a few weeks, several businesses went from recording record profits to wondering if they would still be in business by the end of the year.
Unpredictable expenses can be higher or more frequent in the first few years of business. A general rule of thumb is to set aside six months of business expenses (payroll, rent, etc.).
Why emergency funds are important:
- Economic recessions can be unpredictable, and even the best businesses struggle during recessions. Having an emergency fund allows you to ride out a tough economy and cover essential business expenses.
- A business emergency fund can help prevent you from going into debt or overextending your credit. Debt on top of an emergency can quickly turn an inconvenience into a disaster.
- Equipment breaks. If you have to repair or purchase a crucial piece of equipment, an emergency fund can cover the cost and keep you on track.
- Natural disasters can happen suddenly. Emergency funds help cover insurance deductibles if you are impacted by a disaster like a fire, hurricane, flood, or a business-related car accident.
- As a small business owner, your contributions to the business are crucial. If you are unable to work suddenly due to a medical need or family responsibility, emergency funds can help cover expenses until you’re back on your feet.
- Your clients and customers may not always pay invoices on time. If you’re hit with a big bill and you’re waiting on a late payment, an emergency fund can bridge the gap.
Whether it’s a pandemic, a natural disaster or just an unforeseen lull in profits, events like this remind us that businesses need to prepare for and save for the unexpected.
An emergency fund helps prevent you from having to compromise your financial security if you have a business financial emergency.
That said, there’s a difference between emergency expenses and expected expenses. Make sure your financial plan includes a budget for expected expenses and future expansions. If you need help with your financial plan, check out our article How to create a financial plan for your side hustle or startup.
What is a predictable expense?
Predictable expenses are expenses you know will happen, and you can plan for them. They include things like expanding your business. Creating a savings account to prepare for growth can put you on a long-term path to success.
Why savings accounts are important:
- A business savings account helps you take advantage of new opportunities. If you get your dream order, but struggle to pay for supplies to fulfill the order, the extra money in savings can cover the cost.
- You will likely need to level up your equipment or software as your business grows. Having a savings account lets you take advantage of flash sales or surprise killer deals without going into debt.
- As a small business owner, you will be responsible for paying taxes on your income. Slowly saving a percentage of your income will help take the sting out of paying taxes every April.
- As your business grows, it’s important for you to grow professionally as well. Maybe you want to attend a conference, learn a new skill or join a professional organization. Savings accounts can help you take advantage of professional development opportunities without using credit.
- Once your side hustle takes off, you may need office space or even need to hire some team members. If you’ve already saved for expansion, you can seamlessly grow your business.
- Savings accounts can earn interest so your money can start working as hard as you do.
- There’s nothing worse than getting hit with an overdraft fee. A savings account will provide a buffer to prevent overdrafts.
Having money set aside to cover expenses helps set you and your business up for success. So instead of worrying about how you are going to cover an expense, you can focus on how you are going to grow your business.