Emergency Funds – For People and Businesses!
After years of being a financial professional and talking with my friends as well as people who run small businesses, I've realized that there are many similarities to running a stable business and maintaining good personal finances. What many people don't realize is that the fundamentals of finance will apply to both people trying to make their living and businesses trying to succeed in the market. Today, I'm going to walk through the importance of an emergency fund for both your personal finances as well as your business.
What is an Emergency Fund?
In this context, an emergency fund is cash that you have sitting on the sidelines ready to be deployed at a moment's notice. These funds are not invested as stocks or certificates of deposit because they need to be ready to use in the case of an emergency. For both businesses and individuals, it's recommended you keep these funds in a high-yield savings account that will provide at least some interest on the money instead of nothing. You should treat this money as a simple insurance policy, if you keep one month's worth of expenses on hand, you will be able to survive an emergency where no money is coming in for one month. The same can be said for three and six-month funds, except that larger funds will require more sacrifice on your part to maintain the better insurance policy and give you more peace of mind and flexibility. Depending on how much you saved up, one-off emergencies (such as surprise medical expenses) may be easier or harder to deal with. While the process of setting up such a fund is going to be different for every person in business, the benefits of being able to operate without fear of imminent shutdown in the event of an emergency far outweigh the costs.
When Would I Use a Personal Emergency Fund?
Typical uses of a personal emergency fund can include:
Quitting or being terminated from your job
Medical emergencies
Critical Home or car maintenance
All of the above scenarios could occur on short notice and have a significant impact on your life and finances if not addressed immediately. If you do not have the funds to deal with these as they come up, the effects could compound and seriously affect your mental and financial health. For example, let's say your car breaks down and needs immediate repairs. If you don't have the funds ready to pay for such an event in a timely manner, you have two options:
Go into debt to solve the issue immediately or,
Rearrange your whole life to work without a car until you can afford to fix it
Generally when I hear about people in this type of situation, they would go into credit card debt if it wanted to be fixed immediately, which carries a large amount of costs in the form of high interest rates that can make it incredibly difficult to pay off if you are not prepared. If credit card debt isn't your style, then you would need to find a way to get by without your car until you can afford to fix it. This could be very simple with the use of public transportation, or very difficult with having to coordinate with friends, family members or ride-sharing services to get by until the issue is resolved. Having an emergency fund handy in the situation would eliminate the need to pick from these two terrible alternatives.
What About Businesses?
Businesses also need emergency funds to maintain a smooth operation. The best example that I can think of is a business that has a bad month and doesn't bring in as much money as it usually does. This could happen because of the weather, a global pandemic, or changes in customer behavior. Regardless of why the business didn't bring in as much money, certain bills still need to be paid (because the landlord doesn't care if you had a bad month). If the business doesn't have enough money to pay those bills, then things will head south very quickly. Having funds on hand to support the continued operations of the company without having to go into debt is what separates a strong and stable business from one that is one month away from shutting down permanently. In addition to keeping things operational, having some extra cash lying around will alleviate pressures on management that can create suboptimal working environments.
Whether you're looking at your own personal finances or running a business (or both), I hope this has taught you the importance of having an emergency fund. Hopefully you don't need it, but if you do it will save you from a terrible situation.