Business emergency funds: How much cash should a small business keep in savings?
Running your own business requires tremendous planning, passion, and commitment. It also requires a stomach for the unexpected. Cash-flow hurdles such as delayed payments, slower-than-expected seasons, equipment failures, or damaged inventory can arise. When these situations arise, a well-built business emergency fund can help you cover the gap without dipping into your daily operating cash or taking out a loan.
To build a business emergency fund, you need to understand your regular operating costs; the nature, seasonality, and customer concentration of your business; and your exposure to unexpected expenses and revenue disruptions. Then keep money in a separate business account that you only tap when a true emergency occurs.
What is a business emergency fund?
A business emergency fund is a liquid cash reserve set aside to cover unexpected business expenses, income disruptions or short-term revenue gaps.
“Emergency funds help create a buffer between the time money leaves a company versus the time money enters into the company and create liquidity and flexibility to make decisions based on changing events,” says Alex King, former vice president at Barclays and founder of Generation Money.
Emergency fund vs. operating cash vs. tax reserve
Clear business records that outline your income and expenses allow you to more easily file your taxes and accurately report your income, deductions, and credits. Separate accounts for operating cash, emergency savings, and tax reserves can make it easier to understand what money is available for each purpose and help keep your bookkeeping organized.
How much should a small business keep in an emergency fund?
The amount to keep in your business emergency fund will vary depending on your business. For example, a seasonal business should anticipate emergencies differently than a stable service business.
Start with essential monthly expenses. Then choose a reserve timeframe based on how quickly your business could replace lost revenue. If your business has recurring contracts, diverse customers, and available credit, you may feel comfortable with a smaller reserve than one with seasonal income, one primary customer, or limited borrowing options.
“I encourage clients to maintain enough liquidity to cover three to six months of essential operating expenses, with businesses that have seasonal revenue or longer payment cycles often needing even larger reserves,” explains Zachary Sahar, managing director of Capital Tax.
You can build toward your final target in stages rather than trying to fund the entire reserve at once.
Starter reserve
A starter reserve can help cover essential obligations due within 30 days.
“The foundation is payroll, rent, insurance, taxes, and core software,” recommends Cyrus Kennedy, entrepreneur and CEO of The Ad Firm. “After survival calculations, growth expenditures are prioritized.”
Core reserve
Your core reserve can help your business weather a longer revenue disruption or larger unexpected expense. It can cover several months of operating costs — exactly how long depends on your specific business model and risk profile.
Expanded reserve
Businesses with greater revenue volatility, longer payment cycles or greater exposure to disruption may want to keep more in reserve. This additional reserve may provide more runway during major industry shifts or serious disruptions to your ability to operate.
Business emergency fund formula
Here are the steps to calculate your business’s emergency fund target amount.
Step 1: Determine your monthly costs. Include expenses such as rent, payroll, insurance, debt repayment, utilities, essential software, and critical vendors.
Step 2: Separate essential from optional or deferrable expenses. Determine which costs your business would still need to pay during a revenue disruption.
Step 3: Determine your reserve period. Based on your business profile, risks, and needs, decide how long you want your emergency fund to cover.
Step 4: Multiply your operating expenses by your reserve period. The basic calculation is essential monthly expenses × reserve period = emergency fund target.
Step 5: Recalculate regularly. As your business changes, your emergency fund should change, too. Even if your business itself hasn’t changed, fluctuating economic factors may still affect how you should think about your emergency fund.
Callout box: For example, if your essential expenses total $12,000 per month and your assessment of the business’s risk profile leads you to choose a four-month reserve period, your savings target would be $48,000.
Where to keep a business emergency fund
Your business emergency savings can live in several types of accounts, each with its own pros and cons.
Business savings accounts
Standard business savings accounts may earn interest while providing relatively easy access. They may even link to your business checking account.
Business money market accounts
Money market accounts may offer checking or debit capabilities directly from the savings account. They’re generally easily accessible, but you may be more tempted to dip into the account for non-emergencies if you have easy transaction capabilities.
How to choose a business emergency fund account
You have options on where to keep your business savings, but there are some account features to consider before making your decision.
Fees. The nature of your business emergency fund is that you won’t need to move money in or out frequently once it’s fully established. Therefore, the account should be a long-term place that won’t charge you fees for allowing your money to accumulate there. Compare minimum opening deposits, ongoing balance requirements and transaction fees.
APY. Your emergency savings will, with any luck, remain unused in the account for a long time, so you might as well earn some interest on it. Look for an account with a decent APY, but don’t sacrifice low fees or easy access just to earn a higher APY.
Access. You hope you won’t need your savings, but you want it to be easily accessible if you do, so avoid accounts with penalties for withdrawals or limited access unless they’re part of a longer-term cash strategy.
Deposit insurance. Look for deposit accounts at FDIC-insured banks or federally insured credit unions and verify that your balance falls within the applicable coverage rules. Eligible deposits at an FDIC-insured bank or federally insured credit union are covered up to the applicable insurance limits — generally up to $250,000 per depositor, per insured institution, and per ownership category. Federally insured credit unions provide similar coverage through the National Credit Union Share Insurance Fund (NCUSIF), which is administered by the National Credit Union Administration (NCUA). Coverage depends on factors such as the account owner and ownership structure.
Deposit insurance and large business emergency funds
Your business emergency savings needs are likely to grow as your business grows. But even for small emergency savings funds, you want to understand how much of your balance is insured and whether you need a strategy for funds that exceed applicable coverage limits.
Business deposit insurance depends on a number of factors. For instance, accounts at a single institution that are owned by the same corporation, partnership, or unincorporated association are generally combined when coverage is calculated. That means opening multiple accounts at the same bank does not necessarily increase your business’s deposit-insurance coverage. If your business emergency funds exceed the insured limit, you may want to consider moving a portion of the savings to another institution to increase the amount covered by deposit insurance.
Business accounts held by corporations, partnerships, and LLCs are generally insured separately from the owners’ personal deposits. However, sole proprietorship deposits are generally combined with the owner’s other deposits in the FDIC single-account ownership category, so verify how your business structure affects your coverage.
When to use and rebuild your business emergency fund
Your emergency fund’s purpose is right there in its name: it’s for emergencies. What that means for each business will differ, but unexpected repairs, temporary revenue gaps, delayed payments or other short-term disruptions are what the fund is designed to cover. It should not be where you turn for planned capital expenses or routine expenses when cash flow is proceeding as expected.
In the unfortunate event that you must dip into your fund, make a plan to replenish it once your business has stabilized. You could consider regular monthly transfers until you’ve fully rebuilt it or link replenishment to your monthly cash-flow review.
Common business emergency fund mistakes
Avoid these common mistakes:
Next steps for building your business emergency fund
Your business emergency fund strategy doesn’t have to be complicated.
Once you’ve worked through the formula to determine your emergency reserve target, it’s time to compare accounts. Look for an account that offers a decent APY, low fees, appropriate access, and deposit insurance coverage.
If your cash flow allows, set up automatic transfers to build your fund. Once it’s fully funded, review your target at least quarterly and whenever significant changes in your business or economic conditions warrant an update.
Frequently asked questions
Your business emergency fund amount depends on your essential monthly expenses, revenue fluctuations, seasonality, and more. Determine your monthly costs and then multiply that by the time period you want the fund to cover. More volatile businesses will likely want a longer reserve period, while more stable businesses may be more comfortable with a shorter period. “For me, the right emergency fund isn’t a fixed number. It’s a reflection of how dependable the business’s cash flow is,” says Juan Ignacio Garcia, CEO and partner at L40 Partners.
Should a business emergency fund be kept in savings or checking?
You may want to keep a smaller portion of your emergency fund in a checking account as an immediate access buffer, but keep the bulk of your emergency reserve in a savings account since it isn’t money you need to access for daily use.
Yes, a business emergency fund can be FDIC insured when held in an eligible deposit account at an FDIC-insured bank. The amount covered depends on the account’s ownership category, titling, and the entity’s combined deposits at that institution.
Keep your planned tax obligations in a separate tax reserve rather than emergency savings. That will simplify your bookkeeping and ensure you aren’t tempted to tap into emergency funds for expenses you should otherwise plan for.
