A major customer goes bust, owing you money and creating a potential cash flow problem for the short- and long-term. You’ve got suppliers to pay, a wage bill to cover, and a family to feed. Now what?

When you’re buried deep in the day-to-day running of things, it can be hard to step back and consider how your business would cope if an unforeseen event hits your livelihood. It’s also understandable if, especially during your start-up years when every dollar counts, you might be reluctant to squirrel away money that could be working hard elsewhere. 

However, if the worst does happen, and your business income suffers for days, weeks or even months, you’ll be glad you have a pot of easily-accessible cash on hand.

Why create a contingency fund?

Any number of nasty surprises can hit a business. Here are some of the most common ones:

• A serious illness to you or a vital employee
• A sudden economic downturn
• A natural disaster or severe weather event
• An unexpected market change, such as a new competitor, that reduces sales
• Damage to essential equipment
• Damage to your business premises
• The loss of a key customer, or a customer going bust with unpaid debts
• Theft or vandalism that prevents you from operating
• Loss of online sales because of website hacking or a system failure
• A sudden rent increase that forces you to relocate your business

Having some cash in reserve can help you keep your business running, maintain your cash flow, reduce the need to take on emergency debt and recover quickly.Think back to the worst-case scenario at the start of this article.

An emergency fund could help you maintain positive cash flow and cover the short-term loss from unpaid invoices. With an eye on the longer-term, you could also afford to ramp up your marketing efforts to try to replace the customer you lost. Creating an emergency fund is also simply a good way to save some more money for a rainy day. If the worst doesn’t happen, you’ll still have a tidy sum tucked away.

How to create a contingency fund

Successfully creating an emergency fund is all about good saving habits. Here’s how to get started:

• Be realistic about how much you can afford to save. Don’t threaten your business by putting away too much
• Consider your business expenses, debts and income when thinking about how much you need to save
• Aim to create a fund that could cover you for at least three to six months 
• Talk to a financial or business advisor about budgeting for a contingency fund as part of your general financial planning
• Cut unnecessary costs, such as non-essential business trips or company lunches, so you can save more or build up your fund faster
• Set up automated payments into your fund to help you meet your savings goal
• Find a good place to store your fund, ideally a high-interest account that still provides instant access
• Top up your emergency fund with unexpected windfalls, such as a tax rebate
• Save more when times are good
• Every little bit helps; even, for example, your tips box if tips are intended for you alone
• Keep your contingency fund for real emergencies and don’t be tempted to spend it

Here on Vancouver Island, we’re well aware of being prepared for the “Big One.” A contingency fund is as important to your business as an earthquake preparedness kit is to your home.