The importance of having a financial safety net and not leaving your business exposed

As a business owner, you will know just how varied performance can be.

Revenue is unlikely to be the same from one year to the next, and while some periods can over deliver, others can underperform.

The key to long-term success, through both the ups and downs, is maintaining stability and ensuring that the stronger periods help you weather the tougher times. Building a financial safety net is key to this process.

Read on to learn about the importance of having a financial safety net for your business.

Not having a financial safety net risks leaving your business exposed

Without a financial safety net, your business is left vulnerable to several potential pitfalls. These could be related to business performance, your personal life, or external factors, such as damage to property caused by weather.

Common risks include:

Unexpected costs – Repairs, replacement equipment, and changes in tax legislation.
Loss of income – A key client leaves, trading slows, or contracts expire.
Business interruption – Personal illness or injury, supply-chain problems, and technology failures.
Personal financial pressure – If the business is your main source of income, financial problems in the business can quickly become personal problems.

There are many more examples of risks a business can face, all of which can put immediate pressure on your finances and may threaten the continuation of the business itself.

Financial safety nets come in different forms

The key to protecting yourself against the common risks businesses face is to have a financial safety net in place. This gives you a buffer that can support you during difficult times and can help ensure stability as you try to get the business back on track.

Your financial safety net could either be:

Cash reserves held within business accounts
Appropriate business protection policies, such as key person insurance, income protection, or life cover.

Indeed, you will likely have a combination of the two. Cash reserves can support you through periods of low activity, while insurance can help you cover unexpected costs or losses due to business interruption.

In every instance, it’s a good idea to keep your business and personal finances separate. That way, you don’t need to dip into your personal savings to help support your business.

The size of your safety net depends on your business

Perhaps the most important question when building a financial safety net for your business is: how big should it be?

While there is no definitive recommendation, a broad rule of thumb is to have:

3 to 6 month’s costs for regular businesses
6 to 12 month’s costs for higher-risk or seasonal businesses

When determining how big your safety net should be, consider the following questions:

What are your fixed monthly costs?
What tax bills are due and when?
What are your average non-fixed monthly costs?
How many employees do you have?
How predictable is your revenue?
How dependent are you on a small number of clients?
What is the general risk level in your industry?
Are some times of year always better than others?

Based on your answers to these, you can come up with a clear picture of how much money you will need to cover various financial challenges your business could face.

A financial planner can help you assess your business finances and can use cashflow modelling to project how big a safety net you may need in various scenarios.

5 steps to help you build your financial safety net

Building a financial safety net is about understanding what your business needs to keep operating and gradually putting the right protections in place.

1. Understand your essential monthly costs

Start by working out the minimum amount your business needs each month to stay afloat. This could include wages, rent, utilities, software subscriptions, loan repayments, and other essential overheads.

Having a clear picture of these costs will help you understand how much you may need to cover if your income suddenly falls.

2. Set a reserve target

Once you understand your essential costs, you can set a realistic target for your financial reserve. The right amount will depend on your business and how predictable your income is, as discussed above. The aim is to have enough to give you breathing room if circumstances change.

Keep this reserve separate from money for normal spending, so you’re less likely to dip into it unnecessarily.

3. Build it gradually

You don’t need to wait until you have a large surplus to start building your safety net. Setting aside a manageable amount regularly can help you build your reserve over time.

When business is performing well, consider using some of that additional income to strengthen your financial position, so you’re better prepared when conditions become more challenging.

4. Identify your biggest risks

Think about what could have the biggest financial impact on your business. Could you cope if you lost a major client? What would happen if you were unable to work for a period of time, or faced an unexpected repair or legal expense?

Identifying your biggest risks can help ensure you are prepared for them if and when they eventually happen.

5. Review your insurance and reserves

Review whether your existing protection policies are appropriate for your circumstances and provide sufficient cover for the risks you’ve identified.

Moreover, as your business changes and grows, your needs may change too, so it’s worth reviewing your reserve requirements regularly.

Get in touch

A financial planner can help you determine how much you need to have in reserve to protect your business. They can work with you to build a plan to reach your target, and they can help you review your needs as you progress.

To speak to a financial planner, get in touch.

Email [email protected] or call us on 01625 466360.

Please note

This article is for general information only and does not constitute advice. The information is aimed at individuals only.

All information is correct at the time of writing and is subject to change in the future.

Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.