How to start (and build) an emergency fund

The events of recent years in the global economy have left no doubt about the need for a company reserve fund. When one unpredictable crisis gives way to another, the reserve fund becomes a priority and ensures the enterprise’s survival.

What is a reserve fund?

An emergency reserve fund is a piggy bank with money, to put it simply. Finances are accumulated there for a specific purpose. One company may have several funds. For example:

  • Modernization fund. Money is put aside there for the purchase of new equipment;
  • Growth fund. There is money there to expand production, create and purchase new sites;
  • Personnel fund. Money for education, various pieces of training and programs;
  • An emergency fund is money for a rainy day.

In the event of a sudden drop in profits, the reserve fund is designed to absorb the blow and allow the company to survive difficult times, and sometimes emerge from the crisis with new opportunities.

Where does the money come from?

Money for the reserve fund is taken from net profit. Typically, a certain percentage of periodic contributions is set for the period of the building emergency fund. You can transfer money monthly, weekly, or even more often. It is important not to lose control or get carried away. We recommend performing a monthly reconciliation to ensure that contributions to the fund do not add up to the ongoing costs of running the business. Otherwise, you risk a crisis before you even have time to form a reserve fund.

How many months should the reserve last?

It is clear that the longer the better, but everything has reasonable limits. Most of the reserve funds of enterprises today are designed for three to six months of quiet existence with a cash flow of zero. More precise numbers depend on your capabilities and the specifics of your business.

Where to store and what to spend on

Immediately a specific answer to the second question: no matter what! This is the meaning of starting an emergency fund. This is an emergency reserve, which means there is no need to touch it without reason. There can only be one reason – a sudden collapse in income.

This leads to the answer to the first question. This money must be available. Everyone knows the truth that money should not lie around like a burden, but should always work. The situation with the reserve fund is an exception to the rule.

Let’s say that yesterday you invested your reserve in shares or precious metals, and today, for example, a Covid quarantine was announced. But no one canceled current payments (rent, salaries, loan servicing). Can you quickly withdraw the money you invested yesterday? Is not a fact. Either it will take time, or the operation will take place with noticeable financial losses. Therefore, it is logical to open a separate account for the reserve. Most likely, this will be a deposit with the possibility of withdrawal and replenishment.

You can test the reserve storage option in a simple way. It is enough to know for sure that this money can be available in one day. If possible, it’s a good option, if not, we need to think about it some more.

Algorithm of actions for launching a reserve fund

Below we provide you with the best way to build an emergency fund.

  1. Calculate the required fund size

First, you will need to understand how much money the company needs every month to ensure its livelihood. Most likely, this item will include wages, taxes, excise taxes, purchase of raw materials, and rental of equipment and premises. Next, we multiply the amount by six. If the amount is obviously unaffordable, we multiply it not by six, but by four. In principle, you can multiply it by three; a reserve fund for three months is better than nothing.

  1. Determining the percentage of deductions

Everything here is completely individual. For example, you are engaged in trading or producing sweets. You know for sure that, thanks to New Year’s gifts, the last months of the year will be extremely profitable, and in the summer there will be a decline. Why not create a reserve fund in a couple of months, deducting 50 or 60 percent?

  1. We fill the fund with money

This can be difficult. The fact is that without established financial accounting with a profit, not everything is so simple. There are situations when, although there is an estimated profit, there is actually no money in the accounts. The opposite also happens sometimes. In this situation, you need to calculate the ratio of net profit and revenue. Once you understand what percentage of your total incoming cash flow is profit, you can calculate the percentage needed to contribute to the reserve fund.

  1. Choosing a storage location

As we said above, it is important that the money is stored securely and that it is at arm’s length. We recommend a deposit account with a reputable bank. But this must be an account with the right to deposit and withdraw, otherwise the whole point is lost.

  1. We look at the circumstances soberly

You need to understand that there are situations when no funds will help. For example, you had a casino, but gambling was banned. When the business cannot be saved, the reserve fund will help cover the costs associated with closing the company, and then help launch a new project.

When you can and when you shouldn’t use emergency fund funds

According to experts, the company’s reserve fund should be used only in the most extreme cases. Some believe that even zero profit is not a sufficient argument for using the reserve fund, only losses.

Some say they have managed to never use this fund. They agreed that financial discipline was paramount. This fund is needed only for the most extreme situations, which are difficult to even imagine. Get yourself such an attitude that you cannot touch him, no matter what happens in life. That is, you should not use it at a time when you need to issue a salary, but the money from clients has not yet arrived. This attitude will allow your company to flourish, and you and your employees to look for ways out of any life situations. Better think about how to speed up payments from customers, and how to get more income so that everyone in the company benefits.

Let’s sum it up

  • The reserve fund is the company’s safety net. It should be enough for at least three months.
  • The reserve fund is formed from profits by regular deduction of a certain percentage.
  • This money must be stored in a way that allows for withdrawal and replenishment without penalties at any time.
  • The reserve fund can only be spent as a last resort when the company suffers losses. Even with zero profit, experts do not recommend using a reserve fund.

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