Small businesses face many challenges, and unexpected events like natural disasters, economic downturns, or global pandemics can have a significant impact on their operations. That’s why having an emergency fund is crucial for the success of any small business. But how much cash should a small business have on hand to weather a financial storm?
While there is no one-size fits all answer, the Minnesota Department of Employment and Economic Development (DEED) recommends that small businesses work to have three to six months of operating expenses in cash reserves. This provides business owners a nice safety net should something unexpected occur in the region or the broader economy. But the specifics for your business may be different. How do you determine how much cash your small business should have on hand? Consider these factors when making your decision.
How Large is Your Business?
The amount of cash your small business should have on hand will depend on the size of your business. A small business with one or two employees will likely require less cash on hand than a larger business with 50 employees. Covering salaries and wages can consume a large chunk of your cash reserves if you have a larger business that faces a temporary set back or slow down. The ability to accumulate a sufficient cash reserve is one factor that should be considered if you are considering a business expansion.
How Steady is Your Business?
The nature of your business can also impact how much cash you should have on hand. A business that relies heavily on seasonal revenue or has a high degree of uncertainty in its sales forecasts may need to have a larger emergency fund. Businesses that have steady, predictable revenue streams may have significantly less risk to cash flow disruptions and therefore could require less cash on hand.
What Industry Do You Operate In?
The industry you operate in can also impact how much cash you should have on hand. For example, a restaurant or retail business may need to have a larger emergency fund due to the potential for sudden drops in revenue. Businesses that operate in industries with high volatility may also need to have a larger emergency fund.
Can You Tolerate Risk?
Emergency funds are all about managing risk, so your personal tolerance level is another factor to consider. If you are a sole-proprietor or a member of a partnership where a very small group of individuals are shouldering the risk, you may determine that the tradeoffs of having more operating capital outweigh the threats that may or may not occur. As your business grows and more people become reliant on the income you generate, this risk tolerance level may shift. Be sure to routinely assess the state of your business and your emergency fund over time to factor in changes in both your business and the broader business environment.
Working with Haworth & Company
Having an emergency fund large enough to keep your business in operation is crucial for the success of any small business. How much cash you should have on hand will depend on the size of your business, the nature of your business, the industry you operate in, and your risk tolerance. The team at Haworth & Company helps our clients take a strategic and proactive approach to their emergency funds, providing perspective on the broader economic environment and helping to ensure that their small businesses are prepared for any financial challenges that come along. If you aren’t sure whether your emergency fund measures up, contact us today for a complimentary consultation.