How to build an emergency fund

Saving money and building an emergency fund isn’t fun. In fact, it’s pretty much the antithesis of fun. Saving is the ultimate delayed gratification. Instead of using money today for something you enjoy (or a surprise bill 😓), you’re saving it until there is some unforeseen very unfun emergency. It couldn’t be worse. But, you really do need an emergency fund. It’s like your own little short-term insurance coverage that protects you until legit insurance pays out or a large invoice is finally paid. You’re protecting yourself and self-insuring from all those ‘OH SHIT 😱’ situations.

But, actually building an emergency fund is easier said than done. Unfortunately, we haven’t figured out how to manifest money out of nothingness. And, you can’t keep pushing it off until you land that next big client (which is just a lie you keep telling yourself). You can’t hope that one day you’ll turn around, the stars will align, and you’ll finally have an emergency fund. You need to actively build it. Create savings goals, plot a path, and slowly build that emergency fund up. It could take a few months, but it’ll go a long way in protecting your cash flow and your business.

Emergency fund milestones :

The typical wisdom is to save two to three months of business expenses for a rainy day. And, that’s a good rough starting goal. But, it’s a very lofty and intimidating goal for businesses without any savings and isn’t necessarily a strategic goal for businesses that do have large savings. If you’re just starting your emergency fund, break that big goal into milestones. First, save up enough to cover one pay cycle, then enough for a month’s expenses, then a month’s expenses including your pay, and so on. Slowly build up until you near that two to three months of expenses goal. On the other hand, if you already have huge savings, it might be time for legit scenario planning to figure out exactly how much money you’d need on hand for emergencies and how much can be reinvested into your business (or paid out as a bonus to owners and employees).

Dedicated monthly savings goals:

Once you have your savings targets, break them down into monthly savings goals. Treat them as a necessary expense that has to be paid by the end of the month and not as an ‘if I have enough money’ afterthought. These monthly savings goals should be realistically attainable. Instead of taking your emergency fund milestones and breaking them into six monthly installments or using some contrived ratio, take a look at your finances and figure out how much money you can actually spare per month. In the beginning, that might be very little (like 15 bucks a month), but it’s about getting started and building our way up.

Finding money to save:

Your savings aren’t going to save themselves. The money has to come from somewhere and be deliberately allocated to savings. If you’re not already on track to hit your savings goals, that means we need to find it (and, you mayyy also have a profitability problem). And, the easiest way to find it is by cutting expenses then saving what you would’ve paid (eg, cut a $50/mo software subscription and start saving that $50/mo instead). But, beyond that, you’ll also need to take a look at your overall finances (both business and personal) and work on your profitability. You should be profitable enough to cover all your expenses, slowly build savings, and then some. Make sure you’re charging enough, operating close to capacity, and that your personal financial needs aren’t draining your business of any spare funds.

Use a separate savings account:

Combing all your available cash into one account never ends well. You’ll inevitably forget how much was set aside for various savings targets, overestimate how much free cash you have available, then accidentally dip into savings. Set your emergency fund (and other savings like quarterly tax payments) into separate bank accounts. And, when opening that second bank account to house your emergency fund, make sure they won’t charge you monthly fees. Those monthly fees really add up and turn saving into a ‘two steps forward, one step back’ struggle. There’s plenty of banks and credit unions that either won’t charge monthly fees on extra accounts or will aggregate all account balances when calculating fees.

Keep business and personal emergency funds separate :

Combining your personal and business emergency funds seems like a no-brainer for many consultants, freelancers, and solo business owners. It’s easier, requires less management, and keeps the number of bank accounts to a minimum. But, personal and business emergency funds should be kept separate as two wholly distinct funds. Money might be fungible and every dollar interchangeable, but personal and business savings feel very different. And, when you need to deploy your emergency fund, transferring $10,000 from your business savings to your business checking feels veryyy different than contributing $10,000 from your personal savings back into your business checking. That difference will cloud your judgment.

Don’t automate it (yet):

Most personal finance advice regarding emergency funds suggests automating savings (by either setting up automatic transfers or having your paycheck direct deposited into two separate accounts). And, while that works in personal finance where cash inflows are regular and can be planned around (eg, those paycheck are always deposited on the 1st and the 15th), business revenue isn’t as predictable which makes automated transfers out of your operating account tricky and can lead to accidentally bouncing an important payment. You should hold off on automating transfers out of your operating account until you’ve built a healthy cash cushion in it.

Action Item:

Pick your next emergency fund savings milestone.