In an ideal world, your business would run entirely on the cash it brings in, and you’d never be faced with the need to access alternative funds. Unfortunately, as you probably already know, circumstances are not always ideal, and you might find that you need to access cash quickly.
Having cash on hand, or an “emergency fund,” can help you keep your business afloat during hard times, or address operational or maintenance issues that come up unexpectedly.
To most, the peace of mind this cash promises sounds great, but the bigger question is usually: “How do I gain access to cash on hand, and how much will it cost me?” The good news is that there are a few great ways to build an emergency fund that won’t add to your current costs. Let’s look at your options.
Plan to Save Money Over Time
This will be your best bet at building an emergency fund to fall back on when you need it the most. Saving over time is also the best way to avoid any cost associated with an emergency fund. By putting away a percentage of your profits, you can build a solid nest egg or emergency fund over time.
This of course will require you to review your finances and determine a number that is comfortable and suitable for your short and long-term goals.
Though saving money over time is a great way to build your cash fund, it may not always be the best or most feasible option for you. In some cases, you may need cash immediately, you might not be able to put anything away, or you may not have enough saved by the time you need it.
For that reason, you’ll need to consider some other options that can help provide you with financial security in an instant. Looking at the next two options, there is one you should try to avoid, and one that can prove to be a terrific alternative to saving over a period of time.
Be Cautious About Taking Out a Loan
For many, a loan may seem like a great—and perhaps the most obvious—option, but for the purposes of an emergency fund this should not be on the top of your list. Once you’re approved for a loan and the finances transfer from the lender to you, you start paying interest on the loan until you pay back the entire amount. Keep in mind that some lenders charge a prepayment penalty on loans if you decide you don’t need the loan for its entire duration and pay it back early.
In essence, a business loan represents a costly cash-on-hand strategy. Regardless of how much money you spend or how long down the road you need it, you’ll be going into debt just so you can keep extra cash on hand. Not necessarily the best option.
Consider a Business Line of Credit
This can be one of the best emergency cash options available to you. Similar to a loan, a business line of credit gives you access to a predetermined amount of funds for which a potential lender approves you. You’ll need to apply for these lending options, and your credit history, among other things, will be considered during the approval process.
However, the similarities between the two tend to end there. When you apply and are approved for a business line of credit, the lender agrees to give you access to a specific amount of money to be used at your discretion. How much of that specific amount you use at any given time is entirely up to you.
This means that if you have a $5,000 limit, you can use all or part of that amount. However, you will only be required to repay the amount you used, plus the interest accrued for that amount. Unlike a business credit card, interest is charged immediately instead of after a given payback period.
So if you need to make an emergency repair that costs $3,000, you will be on the hook for $3,000 plus interest, and the remaining $2,000 will still be available for your use at any time.
On top of that, this type of borrowing agreement is considered to be a revolving line of credit. This means that your available credit will fluctuate between the max balance and zero, based on the amount you borrow and the payments you make. Unlike a loan, which is good for the the initial amount borrowed over an agreed-upon duration, a business line of credit will continue to replenish as long as you pay down your debt.
Caveats for a Business Lines of Credit
When shopping for a business line of credit, try to avoid those with monthly maintenance or non-use fees. This final bit of advice is the key to accessing an emergency fund without unnecessary cost. Both monthly maintenance fees and non-use fees will end up costing you money upfront for cash you may not have accessed yet.
This is particularly true if you want to have the cash on hand for an undetermined amount of time. If you’re penalized for not using it, these fees can quickly add up and create another unwanted cash burden.
Before you apply for a business line of credit, be sure to review the agreement and ask the lender about those two fees specifically.
Another Option: Business Credit Cards
Similar to a business line of credit or your personal credit card, a business credit card is a revolving line of credit in which you won’t be charged for unused funds. It is especially important to get a business credit card if you are currently using a personal credit card for business expenses—maxing out a personal credit card can kill your personal credit.
Another great aspect of business credit cards and business lines of credit are that they both will help you build your business credit profile. Building your business credit profile will increase your financial health so you can qualify for trade credit and lower-cost loans in the future.
More answers to more questions:
Why are My Credit Scores Different?
How Often Does My Credit Score Change?
Can I Build Business Credit Fast?
What Happens When You Default on a Loan?
This article was originally written on June 29, 2016 and updated on October 31, 2016.
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