Emergency Funds
When you start a business you will have many responsibilities on your plate. Navigating the challenges and joys of working for yourself is a process, one that takes trial and error to get right.
One point that many new business owners struggle with is money management. Your business finances can sneak into your personal and vice versa. Establishing a clear line between your personal and business finances is key for financial stability.
You probably have a traditional savings account, but what if your car breaks down on a long road trip? Do you have a designated fund for when life doesn’t go right?
What is an emergency savings account?
To help take care of your unexpected broken car situation, you will need a solid stream of cash. These unforeseen mishaps can often get quite expensive which is why I recommend every business owner establish an emergency savings account.
An emergency savings account is a separate, highly liquid account that secures money in case of an unexpected problem.
Remember when we talked about the importance of drawing boundaries between cash flow for your personal life and your business? That concept becomes increasingly important when we talk about money set aside for emergencies. This account should be separate from both your business and personal accounts. This separation works to ensure you don’t dip into it for extraneous spending.
In order to get a better understanding of how an emergency savings works, let’s look at what the money should and should not be used for.
An emergency savings account should be used for:
Loss of employment
Car malfunction
Necessary home repairs
Water leak, pipe burst, plumbing problem, electrical malfunction, roofing issues
Unforeseen hospital needs
Last-minute travel needs to take care of family/friends
An emergency savings account should not be used for:
Planned large expenses
Buying a house, car, or gifts
Business expenses
Recreational spending
Building up emergency savings as an entrepreneur is important so that you don’t have to dip into your business or personal accounts to get you out of a bind. Keeping the account separate will also help you refrain from using it for anything other than a necessary situation.
Emergency savings are for just that: emergencies. With a healthy emergency savings account, you will be able to help keep your finances afloat during hard times.
By nature, emergencies are stressful and taxing. An emergency savings lets you deal with the problem at hand and not have to worry about how you will be able to pay the bill.
Where should the money be stored?
When something goes wrong, you will want to have access to the money quickly. Liquidity is one of the most important factors in an emergency account because it allows for quick and easy conversion into cash.
For this reason, many people choose to build their emergency savings in a traditional savings account. Even though the interest rate on traditional savings accounts are low, they are also low risk and highly liquid accounts giving you quick access to your funds while also keeping them safe.
But a traditional savings account is not the only way to go. Some people decide to put their money into low-risk bonds and some even invest that money in stocks. The stock market does have a higher return on investment rate, but the money is often hard to obtain on a moment’s notice. Weigh all of your options and decide which will be best for you.
How much money should be in the account?
To determine how much money you should build into emergency savings, start by calculating your monthly expenses that you must have.
Rent/mortgage
Utilities
Insurance
Car payment
Loan repayment
Food
After adding up all of these expenses, you may be surprised at how much money you spend on necessities each month. It is important to understand your monthly expenses so that if for example you unexpectedly lose your job, you will be able to support yourself and your family until you can secure new work.
I advise having anywhere from 3-6 months of savings in an emergency account and depends on your unique income and savings situation. This account is meant to keep you afloat during hard times and to keep you out of debt. Without emergency savings, you may have to max out a credit line or take out a personal loan which could spiral into a long, drawn-out debt. Having a cushion to fall back on is important so that you don’t have to go into debt paying off the aftermath of an emergency.
Life doesn’t always go right. Healthy emergency savings will be there to catch you when you fall and keep you on the right path. If you want to discuss specific options that will work best for you, give us a call!