IF there is one lesson for South African business owners to take away from the shock of the Covid-19 lockdowns and the horrors of the recent riots it is the importance of saving towards an emergency fund, says Jeremy Lang, regional general manager at Business Partners Limited.
With each successive blow, businesses that had access to some emergency funds are in a much stronger position today relative to those that had little or no spare resources. Not only will they be returning to their pre-crisis position much quicker, but they are in with a chance to win the market share of those businesses who did not have enough resources to pull through.
The advantages of building an emergency fund go beyond just the access to cash that can pull your business through a crisis, says Jeremy. The very practice of building such a fund instils a disciplined approach to business that pays off in good times too. A business with a culture of saving tends to maintain a lean, efficient operation, making it more profitable when things are going well, and more resilient in bad times.
A culture of saving in a business is built on three key pillars: Planning, patience, and discipline, says Jeremy.
An adequate emergency fund simply cannot be built in a business where there is little forward planning. Even with the best of intentions, a business owner will find it very hard to stash enough away every month without a proper financial management system in place.
The business world is just too turbulent and the temptations to spend are just too numerous for an emergency fund to grow without being embedded in a rigorous plan and budgeting process. Therefore, in order to save successfully, the target size of the emergency fund must be stated explicitly in the business plan, and the monthly payment towards the fund must be a fixed item on the monthly budget.
By elevating a monthly saving amount to a status similar to that of rent or a loan repayment – in other words, it must be paid even if it hurts – will ensure that the fund becomes a reality. Meanwhile, the focus of any budget-cutting activity in your team shifts to wasteful spending and finding more efficient ways of doing things.
How large should an emergency fund be? Jeremy says the idea is not necessarily to carry a business through an entire crisis, especially one as deep and lasting as the Covid-19 pandemic. Rather, it should be aimed at helping a business to survive the first shock of a crisis, and to buy some time in order to raise some finance for a longer-term bridge back to growth.
A good rule of thumb is to have at least three months’ worth of overheads stashed away in an emergency fund, says Jeremy. But if it is particularly difficult to raise funding in your industry, or if your credit record will make it difficult, you would do well to keep a bigger emergency fund.
An important part of your planning towards an emergency fund is to weigh up how much of the surplus generated by your business you need to reinvest so that your business can grow, and how much of it you should set aside as a hedge against a crisis. An emergency fund should only be used in an emergency, and therefore cannot be deployed for business growth, no matter how tempting it is. The amount set aside should therefore be a balance between the buffer needed by the business against shocks and the resources needed for growth.
It is a good idea to separate your emergency funds from the operating cash of your business by keeping it in an investment account. Not only does it provide a psychological barrier against dipping into it, but if it is kept in an investment account it can earn interest so that it does not lose value to inflation. Jeremy says there is a range of stable investment products suited for keeping an emergency fund, including money-market accounts. Make sure that the investment product you choose is one where the funds are easily accessible when needed, and that it is an investment product that prioritises the preservation of your capital.
Some businesses that are fortunate enough to have unused credit facilities such as an overdraft might be tempted to regard those as enough of an emergency buffer and sacrifice saving towards their own emergency fund. Jeremy warns that it is important to understand the fine print of your credit facilities which may allow the financier to reduce or cancel it under certain circumstances. Having your own emergency fund therefore frees you from the whims of jittery financiers.
Looking back over the past year and a half, most business owners can see the sense of having an emergency buffer. For all those business owners thinking how they will start their own savings fund just as soon as they are out of the woods, Jeremy has one more piece of emphatic advice: Start immediately. Don’t wait for the next crisis to arrive.