In the business world, the only true certainty lies in, well, business uncertainty.
Even when you feel like you’re in control, unforeseen challenges will show up.
While there is no foolproof solution to avoiding unwelcome surprises, how you deal with uncertainty can make or break your business.
That’s why you need the right rainy day fund to cover any potential shortfalls and give your business an extra security blanket – all while giving yourself some peace of mind.
Just think – Maybe your business depends on seasonality, or maybe there’s a pandemic that forces you to shut down for some time.
With savings on hand, you can ensure unexpected challenges and periods of snail-paced sales won’t take you by surprise.
But on a shoestring budget (and what small business isn’t?), it isn’t easy to scrimp and save.
If you want to be able to weather any storm that the future holds for your business, keep reading.
In this post, we explore some of the best ways to build a cash buffer for your small business to better set yourself up to cope with any unforeseen expenses.
Table of contents:
- Rainy Day Fund: What Is It, Why You Need One & How Much to Save
- How to Create a Rainy Day Fund for Your Small Business
1. Rainy Day Fund: What Is It, Why You Need One & How Much to Save
In a business world where the Covid-19 pandemic has caused an unprecedented disruption, having a source of ready cash in case of an unexpected slump has become more important than ever before.
So the one big lesson we’ve learned from Covid-19 is that the current business environment is too dynamic and sensitive to know what the future holds.
That’s why you need a cash reserve to deal with expenses that haven’t been forecasted.
You can think of a rainy day fund as a piggy bank to draw upon during adverse times.
This is particularly important for startups and small businesses operating on a tight budget that often have limited sources of liquidity.
However, not all business owners are aware of the importance of having a rainy day fund.
A JPMorgan Chase report based on data gathered from millions of transactions conducted by 597,000 small businesses revealed that most small businesses do not hold enough cash reserves to pull money from during seasonal downtimes or economic downturns.
The report highlights that half of these businesses hold cash reserves that are large enough to cover 27 days of their typical outflows.
The report also revealed that 25% of small businesses hold cash reserves that enable them to cover only 13 days of their outflows.
This means that a quarter of small businesses do not have enough money to continue operations – not even during a one-month cash flow crunch.
You might ask yourself, “Do I really need to prioritise cash reserves if I am able to accurately predict expenses?”
Sure, accurate forecasting may help you effectively plan your financial future.
However, it is downright impossible to predict every expense that could come on the way.
There may be a client who doesn’t pay up, a surge in interest rates, or a pandemic that requires you to temporarily shut down.
Other potential unexpected situations could include tech issues, such as a security breach, legal issues, the unexpected loss of an employee, emergencies that could keep you out of work, etc.
So if you don’t tuck away money for unanticipated expenses, you risk turning to business loans or lines of credit.
However, these funding options can be costly for a small business – not to mention that it can take weeks to secure.
Plus, reserve funds can also open doors of opportunities for your business. For example, you may use savings to purchase heavily discounted equipment or buy a franchise for a good price.
Now that you know the importance of setting aside money to better manage the cycle of ups and downs in business, you might ask yourself how much of a cash buffer you need.
Probably you are already familiar with the typical advice on buffer funds.
The general rule of thumb is that you should put aside 10% of your monthly revenue.
However, the amount of cash you need to reserve mostly depends on factors such as:
- Your daily cash flow volatility: Conduct an accurate cash flow analysis to determine the liquidity and solvency of your business.
- Cash flow forecast: Estimate your future sales and expenses and consider any major expenses that may come your way.
- Accounts receivable: If your business’s accounts receivable turnover ratio is low, you should have more cash reserve.
- Business size: For example, if you’re operating as a sole trader, your personal savings may allow you to run your business with negative cash flow for a while. But if you run a mid-size company and need to pay employees, your cash reserves need to be larger.
- Staff payroll: If you have a team of A-players, you need to ensure that you set aside enough money to cover their salaries and benefits for however long you think it might take to get your business back on track.
- Business goals: For example, if you’ve taken over a new project, you may want to consider hidden costs and unexpected expenses, so build up your cash reserves accordingly.
- Inventory: If you have a slow-moving inventory, you should consider building larger cash reserves.
Considering all of these factors should help you get an idea of how much savings you should tuck away so you can rest easy knowing your business is prepared for anything.
According to The Balance, it’s best to have cash reserves of three to six months’ worth of operating expenses.
However, how much money you want to set aside depends on your saving ability and level of comfort.
It is important to find the right amount that isn’t too high or too low (saving too much or too little can both put your long-term goals in jeopardy).
For example, if your business has too much money you do not put to work, you risk missing out on projects and investments that would otherwise generate attractive returns.
That said, let’s explore some of the most effective ways to set up a rainy day fund for your business.
2. How to Create a Rainy Day Fund for Your Small Business
One way of creating a rainy day fund for your business is to earmark a percentage of your revenue for that purpose.
But the problem is that for a small business where every dollar counts, building a cash reserve is easier said than done.
When you are just starting out, it can be extremely difficult to save money – especially if you are barely making enough money to cover your expenses.
If your business is not swimming in money, the first step is to decide that creating a rainy day fund is a priority.
You can do that by including savings into your annual budget.
Here are some ideas to help you build a business cash reserve:
- Start small and build up
Putting aside a bunch of money right away isn’t always the best idea.
Firstly, putting too much money into your savings account at once may be hard to sustain.
Not to mention that piling too much cash into your savings has a cost called opportunity cost as the money could be put to better use elsewhere.
Secondly, you may even get frustrated as you realise you are not able to meet your ideal savings figure in one attempt.
If you feel like building a rainy day fund is an impossible task, then you’re more likely to give up in just a few months.
That’s why it’s best to start small and keep it steady – all while setting an achievable savings goal.
- Set boundaries
One of the most difficult parts about creating your rainy day fund is resisting the temptation to dip into your savings whenever you feel like it.
One way to set boundaries and resist spending temptations is to put your reserve funds into a separate savings account. This makes managing your money so much easier.
Make sure you also have clear ideas about when you can and cannot take cash out from your cash reserves.
- Cut costs whenever possible
One of the most effective ways for building a rainy day fund is to trim expenses and avoid unnecessary spending.
For instance, you may want to look at your insurance and reevaluate it to ensure you get the proper coverage at fair market value.
Or, you may want to evaluate your office space and see if you can work out of less space. Depending on your business model, you may also want to ditch the traditional office lease and set up a cost-effective virtual office.
For example, here at B2B HQ, we provide professional virtual office spaces that come with the same benefits as traditional offices, but at a fraction of the price (just over $2 a day).
- Automate your savings
Putting your savings on autopilot is much more efficient than remembering to put money aside each month.
If you’re not consistently saving a portion of your revenues, it’s easy to get off track and save less or even skip saving money for a month.
That’s why it’s best to automate your savings and turn your deposits into a monthly expense so you can prioritise your savings goals.
When you automate your savings you actually make a commitment to creating a rainy day fund for your business.
Conclusion: Most of us like a relaxing walk on a sunny day, but what if it turns into a dark, cloudy storm, leaving you drenched and shivering?
That could happen to your business’s finances too.
Not to mention that Murphy’s Law states that these sorts of events always happen at the worst possible time.
For this reason, setting aside funds will help you prepare for uncertainties and keep your business going in hard times while ensuring there is a last resort you can depend upon.
Plus, rainy day funds allow you to reevaluate your budget and trim unnecessary spending so you can tide your business over in its early stages and manage cash flow peaks and valleys.
That’s why a rainy day fund can mean the difference between surviving or failing in an unexpected event.
Want to significantly reduce the cost of running your business from commercial office space? In Melbourne the cost of traditional office space is extortionate, making it much more difficult to save money and create a reserve fund for your small business. But with a professional virtual office, you get a presence in a prestigious location for a nominal monthly fee. Contact us for more information about our virtual office services.