If there’s one lesson that came out of the Great Recession, it’s to keep a cash cushion so your business can ride out disaster.
But how much should you tuck away? And where should you put the money? Those are not easy questions to answer, and there’s a personality component to them too. What feels like a comfortable safety net to one person, may feel like an inefficient over-allocation of cash to another.
Consider the Big Picture
How much you put in your emergency fund will determine if your company has the wherewithal to respond to bumps in the economy—or big, unexpected expenses—without falling behind on bills or resorting to measures such as discounting to generate cash or employee layoffs to slash expenses.
“It’s not just about, 'Gee whiz. We may need a couple of extra dollars so how much cash should we have on hand?'” says attorney Andrew Sherman, a partner in Jones Day, and primary author of Essays on Governance: 36 Critical Essays to Drive Shareholder Value and Business Growth. Consider your long-term goals and the company culture and reputation you want to maintain when determining the amount. “This is an issue of leadership,” he says. How much to set aside? Sherman advises enough to cover six months of operation.
Tony Ellison, CEO and founder of online office products retailer Shoplet, extends his emergency fund beyond employees’ salaries to cover 401(k) matches, bonuses and profit sharing, too. Shoplet also keeps some money available to cover unexpected growth opportunities. While these additional funds are not specifically set aside for emergencies, they do allow the firm to quickly move on new opportunities. In other words, build a “sunny day fund” to complement your rainy day fund.
Do a Risk Assessment
Think of Sherman’s six months as a rule of thumb. The actual size of your emergency fund will depend on your industry. Is there a high risk of being sued by a customer? Are you in an industry that’s heavily regulated by government—and therefore at risk of facing fines for noncompliance? Then you’ll probably need to err on the side of caution, even if it means paying yourself less to free cash for an emergency fund, Sherman suggests. But if you’re in a relatively low-risk business, you might be able to get by with a little less. Some businesses may be fine with three to six months of cash in an emergency fund.
Park Your Cash Wisely
An emergency fund won’t do you much good if you have to wait until the stock market recovers from a dip to get to the money. But a standard business bank account may not be the best place to stow it if you want to get some kind of return on your cash. Low interest rates have sparked Shoplet to invest its emergency fund in low-risk, short-term municipal bonds. “They were yielding more than money market funds, which allows us to accrue some funds,” Ellison says.
Consult with your financial advisor before you start socking it away.
Elaine Pofeldt is an independent journalist and editorial consultant who specializes in small business, entrepreneurship and careers. A former editor at Fortune Small Business magazine, she has written recently for Fortune, Money, Crain’s New York Business, Working Mother and many other publications. She is co-founder of $200KFreelancer, a community for freelance professionals, and Endhousearrest.com, for homeowners looking to sell.
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