Your Small Business Contingency Fund
Feb 9th, 2009 by admin
My blog post “When to Throw in the Towel on Your Small Business” led to a flurry of unexpected emails – with a number of entrepreneurs asking about contingency funds. What are they? Why are they necessary? How much should you budget? And how do you go about establishing one? Well first off, a contingency fund (or contingency reserve) is simply money that you budget and set aside in case of a financial emergency – when something unexpected happens (i.e. a critical piece of equipment breaks down) or when projected income does not materialize for whatever reason (leading to insufficient cash flow to cover operating expenses). You need to have a backup plan to protect your small business – to safeguard your livelihood.
Ready to get started? Here are the steps for setting up your small business contingency fund:
- Determine how much is necessary and should be set aside. Most financial experts recommend that small businesses save the equivalent of one- to three-months’ worth of operational expenses. At the very least, you should have one month’s worth of common and routine expenses set aside – but shoot for three. And don’t get too conservative. Having too much money sitting idle is not smart. These are funds that could be put to good use – to grow or expand your business. Keep in mind that the size of your debt will also play a vital role in how much you should have placed in a contingency fund. If you’re debt-heavy, three months may not be enough.
- Decide where to place the funds. You’ll want this account to be flexible, but not too accessible. Many small business owners opt to place their funds in high interest yielding savings accounts or other ‘liquid’ accounts that allow access to the money quickly when needed. You should also set this up as an automatic transaction or transfer. For example, once a month you can have the budgeted funds transferred from your business checking account into your business savings (contingency) account. Consider using a local bank or other financial institution as opposed to an online bank where things tend to take a long time to process and clear.
- Define ‘emergency’. And make sure this description is noted in your company business or strategic plan. This will differ from business to business.
You never know when a major client will go belly up or mother nature decides to strike without warning – leaving your business in a financial crisis. So prepare for the unexpected by setting up your small business contingency fund today. It’s quick, prudent and an absolute necessity.
I think it’s prudent — essential, really — for business owners to keep some management reserve, a rainy-day fund, if you will. As an eloquent, wise man once said, “S#@t happens.”
And I think many business people should consider interruption-of-business insurance. Can you spell nine-eleven? Katrina? You don’t have to be dark for months on end to be in a world of hurt. Can you withstand even a week’s loss of revenue?