Do you keep an umbrella in your car or carry one when you think it might rain? If so, then you understand the reasoning behind an emergency or rainy day fund for your small business. A rainy day fund is a cash reserve you set aside. The fund is similar to giving your business an umbrella, protecting it from the storms of challenging economic times, such as low sales months or long periods of slow cash flow.
How Much Should You Place in Your Rainy Day Fund?
Generally, setting aside three to six months of operating expenses gives your small business a solid rainy-day fund. Some enterprises have more access to funds than others. If you have limited access to financial resources, the more money you’re able to set aside for your fund, the longer your business can withstand potential financial pressures.
In deciding how much money to put in your rainy day fund, you might consider your tolerance level for business risk, your alternative revenue streams, and how sensitive your business is to changes in the economy. If your risk tolerance is low, you have few alternatives for revenue, or your business reacts strongly to seasonal or economic changes, you may feel more comfortable setting aside a greater amount of money.
Handling Your Rainy Day Fund
When creating your rainy day fund, the easiest way to save is by designating a specific amount in your monthly budget. Try to avoid the temptation to use the funds for a non-emergency, thinking you can replenish the amount later. It’s wise to put the money in a safe place, preferably a no-risk financial vehicle that earns interest or dividends, such as a savings account or short term certificate of deposit (CD). Using a separate account makes it more difficult to dip into the fund, reducing temptation. Once you set up the reserve and you’re comfortable with the amount, you can separate it from the regular cash in your balance sheet.
Your rainy day fund provides business protection, similar to an insurance policy. It empowers you to continue operating your business during a variety of emergencies and difficult circumstances. While you may never use your fund, an old saying that applies to umbrellas applies to rainy day funds: It’s better to have it and not need it than to need it and not have it.
Periods of low cash flow can slow your business growth or increase the need to dip into rainy day fund reserves. Improve your cash flow with invoices, payments, and expense tracking. See how much cash you have on hand with QuickBooks.