9 min read

10 Reasons Why You Need an Emergency Fund


Kacie Berghoef
Entrepreneur and Freelance Expert
Contributor
emergency fund
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The news is out on Americans and emergency funds, and it's not good. According to a recent survey from Bankrate's Financial Security Interest, 29% of Americans lack any kind of emergency savings fund. Of the 71% who have some type of emergency money, most don't have the three to six months of savings that the majority of financial planners recommend. In fact, only 22% of the respondents had six months of emergency savings in their savings account, while the majority of respondents reported having "some savings" but less than the minimum three months of living expenses. Perhaps even more startlingly, over 10% of respondents didn't know how much money they had in savings.

Although no data exists on entrepreneurs and emergency funds, it's likely their saving habits are similar to the general population. Having a savings account is important for anyone, even those who work a salaried job with a paycheck that remains stable on a weekly basis, but for a number of reasons it's even more essential for entrepreneurs to financially protect themselves.

Here are 10 reasons not to wait and to start building your emergency fund today.

1. Your Income is Less Predictable

Employed adults generally know what their income will be from month to month. They have a salary that remains consistent, or an hourly job with a consistent number of hours. As an entrepreneur, your income will vary each month depending on sales. This creates what's commonly called a "Feast or Famine" cycle.

Every business has times of year when sales are high- that's what you're feasting. Unfortunately, there are also times of famine when sales tend to be slower. For example, if you are in retail you're likely to see a high volume of sales around the holidays, with large decreases in January and Februrary. A business like freelance writing or editing will likely see a slowdown in December, when clients have lower need for your work. Every business, regardless of industry, will sometimes have unexplained high and low periods of sales.

During slow months you'll still need to pay all of your business expenses and keep a roof over your head. With an emergency fund, you'll be able to keep paying your bills during unexpectedly long lean periods. You'll also have a place to set aside money when sales are high, in anticipation for these needs.

2. You May Become Ill

Even if you're young and healthy, there's always the possibility that you'll become ill. If you've ever worked as an employee, you probably remember waking up with a cough or the sniffles and calling in to your boss to take a sick day. As an entrepreneur these days are over. When you're sick, you'll either need to power through and work, risking prolonging your illness, or take the day off without earning money.

In the case of extended illness, the problem expands. Although the self-employed, like employees, generally qualify for short and long-term disability, it's harder to get than it is for employees. You'll also earn less money than if you were working. Furthermore, employees usually can take Family Medical Leave Act (FMLA), ensuring their job will be there when they return. As an entrepreneur, you may find your business takes time to regain footing after a prolonged absence. An emergency fund will allow you to rest and recover without worry from short and long-term illness.

3. To Allow You to Handle Personal or Family Emergencies

Like illness, emergencies happen when we least expect them. Whether it's waking up one morning and your car won't start, or rushing to a loved one's side or a funeral, unplanned life events always have unexpected expenses associated with them. In addition to paying for the repair or plane ticket, you won't be able to take paid vacation or emergency leave, increasing the money you lose during these times. Many entrepreneurs have had to put off meeting their basic needs or tell someone they care about that they can't help them in order to keep their business running. By having a solid emergency fund, you'll assure yourself you won't be one of them.

4. Unexpected Business Taxes and Fees

No one likes an unplanned visit from Uncle Sam, and self-employed people tend to get unappreciated notices from the IRS more than employed folks. As an entrepreneur, you pay taxes quarterly, based on the amount of income you predict you'll earn that year. It's often notoriously difficult to predict your earnings, especially in the early years of entrepreneurship, and if you underestimate, you might end up owing a significant amount of money at tax time. The news gets worse; if you take too long to pay, you'll end up owing interest, and the IRS may garnish your earnings.

As an entrepreneur, it's important to set aside additional money for April 15. Along with taxes, your business may owe fees depending on the state you live in, such as an annual cost for the privilege of incorporating in your state. You may also owe tax in additional states if you've done business in them. If you've been keeping an emergency fund, you'll be able to pay any unexpected taxes and fees without worry of interest compounding.

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5. In Case of Unanticipated Legal Difficulties

All businesses run the risk of getting sued, even when they're run ethically and comply with the law. Oversights happen, as well as encountering litigious customers. There may also be a time when you need to sue if a vendor breaches their contract or a client fails to pay. Legal expenses are notoriously expensive, even if you're in the right, and can quickly cause a thriving business to plunge into bankruptcy. A robust emergency fund will help you pay legal fees, and use your right to sue when it becomes necessary.

6. To Avoid Going into Credit Card Debt or Taking High-Interest Loans

Without an emergency fund, it's easy to get desperate in emergencies. Many entrepreneurs, just to keep the business alive or pay their rent, end up putting unanticipated expenses on credit cards, taking out high interest loans, or borrowing money from family and friends. Credit cards have exorbitantly high interest rates associated with them, as do emergency loans taken with limited collateral. Family or friends may or may not charge interest, but you'll end up feeling indebted to them and risk straining your relationships if you can't pay them back.

Taking on risky lines of credit puts your business even deeper in the red, leaving you with a deeper hole to climb out of and greater pressure to make sales immediately. With an emergency fund, you can quickly cover expenses without having to take out interest or risk your relationships. Replenishing a fund is always simpler than paying back a high-interest loan.

7. Easily Cope With Expensive Business-Related Emergencies

Similarly to personal emergencies, business issues take up a great deal of cash reserves. You may have your storefront broken into, a critical machine break, or an important vendor dramatically increase their rates. Many of these challenges cause businesses to stop operating for the duration, until you're able to fix the problem. Without the cash reserves to handle these situations, you'll find yourself unable to make the income needed to continue surviving. With an emergency fund, you can handle expensive business problems quickly and get right back to work doing what you do best.

8. Cover Employee and Staffing-Related Needs

When you hire your business's first employees, you make a legal and moral commitment to paying their salary no matter how your business is doing. Along with salaries, hiring employees comes with a number of expected and unanticipated expenses. You'll need to pay payroll taxes, and provide sick leave, and paid breaks according to state law. If an employee has a long absence protected by law, you may need to pay additional money to hire temporary employees. You'll also find yourself spending money to train or retrain employees, particularly if an employee resigns unexpectedly. Your emergency fund will help you fund any expenses related to hiring and maintaining your company's staffing.

9. For Help During Unexpected Changes in the Market

As veteran entrepreneurs and small business owners know, one can only remain successful in business if the market demands their product or service. Any business can find, even after years of success that consumers no longer have interest in the types of products they make. At this point, you will have to reevaluate, making changes of various kinds that renew interest from your customers.

Making major changes in a business often costs a great deal of money. Along with reduced income from weaker sales, you may need to hire marketing consultants, retrain or take on additional employees, and take time and money to design a new product. Unexpected costs, such as redesigning a website or even needing to move to a new state to capture the ideal market, also come up unexpectedly. An emergency fund will enable you to change the direction of your business without entering dire financial straits.

10. In Case You Need Immediately Accessible Money

Often, businesses tie much of their money up in stocks, investments, or high-interest accounts that are difficult to access. In the long term, making these financial moves is smart, as it allows your money to grow more than in a traditional savings account. However, when you need it immediately, withdrawing from these accounts often isn't possible right away or requires you to incur substantial penalties. An emergency fund assures you that you have some liquid cash on hand in case of the unexpected. It also provides you with a traditional, stable line of cash in case of unpredictability in the market.

How to Start an Emergency Fund

Even if your business doesn't have a large cash flow yet, you can still prioritize starting an emergency fund through a few simple steps. First, complete an operating budget worksheet, predicting your expected earnings and expenses. Create a line item in your budget for emergency savings. Ideally, you'll want to start out by earmarking a minimum of 3-5% of your anticipated earnings into your emergency fund. If you can afford to put in an even higher percentage until you have six months of expenses, that's even better.

After determining the amount of money you'll put into your fund, you'll want to open a personal savings account to stash the money. A savings account will make sure you have the money available immediately, in case you need it right away. Once you've opened a savings account, you can easily set up an automatic transfer to move a set amount of money into your account every month. You can rest easily knowing that in case of the unexpected, you'll have the money you need.

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Kacie Berghoef Entrepreneur and Freelance Expert
I am a writer, Certified Enneagram Teacher, and author of "The Modern Enneagram." In 2013, I left my salaried job to become an entrepreneur. In the years since, I've not only learned an astonishing amount about the practical aspects of being a self-employed freelancer and consultant, but also how to create a business that aligns with your own personal goals and needs. Self-employment is an ongoing wonderful journey that I look forward to sharing with you!
I am a writer, Certified Enneagram Teacher, and author of "The Modern Enneagram." In 2013, I left my salaried job to become an entrepreneur. In the years since, I've not only learned an astonishing amount about the practical aspects of being a self-employed freelancer and consultant, but also how to create a business that aligns with your own personal goals and needs. Self-employment is an ongoing wonderful journey that I look forward to sharing with you!

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