The ultimate guide to calculate your emergency funds requirement.
What is emergency funds ?
The emergency funds are basically the money which is kept liquid cash or a savings bank account for emergency purpose. Everyone needs emergency funds. But the calculation for the individual and a person who managing the business is different. An salaried employee basically relies on his month on month pay check. Basically he has the steady cash flow until unless any job loss occurred. But for a entrepreneur the cash flow is not consistent on each month. So based on person to person we need to use different set of calculation to create the emergency funds.
Emergency Funds – How much an individual needs ?
Basically if you are salaried employee and if you feel your job is very safe generally try to accumulate the 3 months of your monthly fixed expenses. If situation goes unfortunate you can manage your fixed expenses for the next 3 months. You can use your emergency funds as defense and you can stay away from taking personal loans.
There is a famous budgeting strategy called 50/30/20 rule. 50% of your income needs to go towards monthly needs like paying rent, gas etc. 30% needs to go towards wants like Credit card loans, Car EMI and remaining 20% needs to be saved every month. If you are saving 20% of your income every month towards this emergency cash it will take approximately 8 months to reach your goal of saving 3 months fixed expenses which is basically 1 and half month equivalent salary.
Once you attained this goal try to accumulate 6 months of fixed expenses. If you country banks allows you to pledge gold and get loan for emergency then you can keep portion of this emergency funds as gold. It will provide you perfect hedge against the inflation.
So if you are salaried individual you need 3 months to 6 months of fixed expenses. Sudden job loss or small medical emergency will not financially drag you down.
How much emergency funds an entrepreneur needs ?
The way of managing finance as the individual and as the entrepreneur is entirely different. As a entrepreneur you might required to manage the payroll, vendors payments, infrastructure expenditures etc. Also the cashflow may not consistent with your customers. Some might be paying 15 days cycle and some might be taking 90 days to clear the outstanding invoices. So keeping 12 months of operational expenses on each financial year will help you to focus on the strategic vision of your organization.
Without any stress you can focus on new plans and initiatives and if things goes negative you can setup the turn around plan without worrying about the finance. If you are maintaining low operational cost (Basically the emergency cash) then month on month you might need to chase the money from your customers.
Bottom Lines:
Finally we would recommend to keep
- Salaried individual – 3 months to 6 months
- Entrepreneur – 12 Month of operational expenditure