Why You Need an Emergency Fund for Your Small Business

It could bail your business out of a bad situation.

Inflation has been a major problem for consumers for well over a year now, and many have been forced to rack up costly credit card debt just to stay afloat. But small businesses are feeling the strain, too. And in late 2022, 33% of small businesses pointed to inflation as their most pressing problem, according to the National Federation of Independent Businesses.

But while many small businesses are struggling now due to inflation, that's not the only financial hiccup your business might encounter. From rising materials costs outside of inflation to a recession or a general drop in consumer demand, you never know when your business might hit a rough patch. And the best way to prepare is to build your small business its own emergency fund.

Your business needs a backup plan

As an individual consumer, you may be aware that it's important to have money socked away in your savings account for unplanned expenses. Well, you need the same sort of setup for your small business.

You never know what sort of cash crunch your business might land in. It could be something as simple as your largest client being late to pay an invoice that constitutes half of your revenue for the month. Or, it could be a matter of your largest client pulling its contract or ceasing to use your services for a variety of reasons, leaving you to scramble to make up that revenue elsewhere.

Either way, your goal should be to put some money aside in case your business either needs a cash infusion or sees its revenue decline. That way, you'll be better protected -- and less likely to be forced to shut down if things take a turn for the worse.

Borrowing shouldn't be your fallback option

It's not uncommon for small businesses to borrow money when needed. In fact, many small businesses sought out loans at the start of the COVID-19 pandemic, when temporary closures resulted in a massive drop in revenue.

But borrowing should really be your last resort option as a business owner, not your go-to plan. These days, interest rates are up across the board thanks to the Federal Reserve's quest to combat inflation. And so if you take out a small business loan, you may not be happy with the interest rate attached to it. And you might truly struggle to get that loan repaid.

Also, it's not a given that you'll qualify for a small business loan. So a far better bet is to have some money set aside in case things turn sour.

As far as the amount of your small business emergency fund goes, well, that depends on your needs. With personal emergency funds, the rule of thumb is to save enough to cover at least three months of expenses. You may want to do the same with your small business -- sock away enough cash to cover three months of rent, payroll, and other expenses you know you're on the hook for.

But it also never hurts to save beyond that threshold. Keeping money in savings for your small business means having less to invest in your business. But it also means buying your business the protection it needs in case things get tough, whether due to a broad issue like inflation or something impacting your business specifically.