Business Emergency Fund: What It Is and How to Build One
- Melissa Mittelstaedt
- Apr 12
- 4 min read
Updated: Apr 14
Yeah, yeah. We’ve all heard the term "emergency fund,” but have you heard of a business emergency fund?
I’m going to walk you through the following:
What it means.
How to account for one.
Where to keep it.
When to use it.
A Business Emergency Fund: What It Means
In layperson’s terms, it’s a pile of money available for your use when something goes awry. In business jargon, it’s a reserve of money set aside to cover unexpected expenses or disruptions in business operations.
I would like to clarify: an emergency fund is not the same as having cash reserves to stabilize month-to-month revenue fluctuations. If you want to learn more about that distinction, check out my blog “How to Organize Business Finances with the COAST Method.”
As PNC puts it, “An emergency fund is a critical tool businesses can use to safeguard their operations and their assets.” Here’s what that looked like in real life…
The number one example of this from my lifetime was during our COVID era. If you ran your own business during that time and still had expenses to pay, it was a bit of a nightmare. During that time, I was a full-time sign language interpreter. All of the work I was doing was on-site… until it wasn’t anymore.
The U.S. Small Business Administration did initiate Paycheck Protection Program (PPP) Loans, but the first two rounds (if you filed right away) were based on net revenue and not gross revenue. Which made no sense to me, but I wasn’t asked… this left me with a very small loan disbursement to cover my business & my personal life.
Luckily, I had a personal emergency fund. Unfortunately, no business emergency fund.
That experience made one thing VERY clear: a personal emergency fund and a business emergency fund are not the same thing.
COVID was a big, visible, everyone-felt-it kind of emergency. But most aren’t. If you have large contracts and one suddenly cancels, will you have the funds to weather a few months while securing another client?
A Business Emergency Fund: How to Account for One
When trying to decide how much to put into your emergency fund, the financial industry’s recommendation is anywhere from three to twelve months. I know, that’s a big variation! So let’s talk through how you decide.
Let’s start with a list of questions to ask yourself:
Do you want to look at your expenses as a whole? Or from a skeleton budget perspective?
If you look at your expenses as a whole, you’ll want to look at the last 12 months, get that total & divide by 12 to get your average monthly expense total.
If you prefer to use a skeleton budget total, go through your monthly expenses and determine which are must-stays and what you would cancel/stop using in an emergency.
(Note: If you’re an LLC, your owner’s draw won’t be included in that expense total, so make sure you include that.)
Does your payroll cover what the household needs, or do you need to account for distributions as well?
If so, make sure you grab that average monthly number as well.
Is your income dependent on a few clients, or are you diversified?
If your business model is high-ticket 1:1 coaching, losing a long-term client unexpectedly can be extremely disruptive to your business, so you’d need more in your emergency fund.
If your business model is highly diversified, you might not need as many months in your emergency fund, since your cash reserve fund can easily step in on a month-to-month basis.
What is your level of risk aversion?
Yes, there can be a simple formula for all this. However, if you don’t take into account your own nervous system, you’re overlooking a very important piece of the puzzle. I typically recommend asking yourself…
Would 3 months feel good? Let your body give you a hint. Yes or No?
If not, go to 4 months. And so on.
(Note: Be honest with yourself. If you’re a natural money hoarder [no judgment], make sure you aren’t declaring the need to have 36 months saved up just because.)
A Business Emergency Fund: Where to Keep It
You’ll want this money somewhere you can get access to it fairly quickly.
-> Good: In a separate checking account
--> Better: In its own savings account (perhaps a money market account)
---> Best: In its own high-yield savings account (this way you can at least earn some interest on the money while it hopefully sits there untouched)
(Note: If your business emergency fund is greater than $250k, you’ll need to think through your options of splitting up that money since the FDIC & NCUA only insure up to $250k per person per institution. Another option is using an institution that is part of the IntraFi network. Click here to learn more about the IntraFi network from this NerdWallet article.)
A Business Emergency Fund: When to Use It
There are really only a few instances where an emergency fund comes into play, several of which have been mentioned already, but let’s list them out for a refresher:
Natural Disaster/Disruption
Sudden extreme revenue loss
Personal Illness/Injury
If you’re thinking– “Okay… I want to have this, but I’m not sure what I have to work with right now,” that’s exactly what my 90-Min Financial Outline is for. You’ll know how much money you have across all of your accounts so that you can make a real game plan–whether that’s starting your business emergency fund or figuring out where it fits in the bigger picture.
Melissa Mittelstaedt
Financial Consultant | Accredited Financial Counselor®
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