When Disaster Strikes: 3 Ways Small Businesses Can Be Prepared

When Disaster Strikes: 3 Ways Small Businesses Can Be Prepared
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No matter how smoothly your small business is running, sometimes things break -- figuratively and literally. Be it a natural disaster like a tornado or earthquake, an equipment failure or even the death or illness of a key business owner or employee, it's smart to be prepared for the worst.

Here are three ways to prepare your small business for a disaster, an emergency situation or a major slowdown.

1. Create an emergency fund

An emergency fund is money you've socked away to handle the unexpected. Instead of having to take drastic measures, such as laying off employees or paying vendors late, you can tap into these funds and replenish them when business gets back to normal.

How much money to save depends on your monthly expenses and what type of business you run. In general, businesses should aim to stash away at least six to 12 months of expenses, says Michael Sander, a financial planner in Tarrytown, New York.

"It's probably better to be on the 12-month side," Sander says. "Because if you're talking about loss of income, who's going to be paying the rent, paying salaries and other expenses?"

Saving up to 12 months of expenses may sound difficult, but there are a few actions you can take to get there. Look for ways to cut monthly expenses without hurting revenue: Negotiate better terms on your lease or move to a cheaper office space, cut back on travel, sell unused equipment, or reduce utility bills by using energy-efficient appliances.

There's also the question of where to keep the emergency funds. Consider a business checking or savings account that you can access at any time. Ideally, the account should carry few or no fees, have no restrictions on how often you can make withdrawals, and even pay you some interest on your deposits.

2. Open a business line of credit

Of course, not every small business -- especially startups with limited operating histories -- will be able to stash away six to 12 months of expenses. For additional access to capital, a business line of credit could come in handy while you build up your cash reserves.

You can borrow and repay from a line of credit on an as-needed basis (as long as you don't exceed your credit limit), and you'll only pay interest on the funds you've borrowed, similar to how a credit card works. If you open a business line of credit but don't actually borrow anything, you'll make no payments. This flexibility makes it a great option for handling unexpected expenses.

Sander cautions, however, that banks may cancel your credit line if you fail to use it within a certain time frame.

"It doesn't cost you anything to open, but over a certain amount of time if it's not utilized it can go away," Sander says, "so you may just want to take out a small balance so it's active."

And not all business lines of credit are created equal. It's smart to shop around, comparing the terms and fees of each product before applying. Other factors to consider: the annual percentage rate (the annual cost of borrowed funds, with all fees and interest included); the maximum credit limit you can qualify for; repayment terms; type of interest rate (fixed or variable, meaning your rate and payments can change based on the market); and whether collateral is required.

Another note of caution: Banks can close off your line of credit if something about your business changes and your ability to repay the lender weakens, says Steven Podnos, a financial advisor in Merritt Island, Florida.

"Let's say there's some major disruption in the financial planning world and everyone's income is going down, and they see my business is becoming shaky," he says. "So just when I need it, they may change the terms or stop it. It can't hurt to have it, but I don't think I would rely on it."

3. Make sure you're properly insured

Small businesses can be protected from losses by the right types and amounts of insurance coverage, which can vary according to the type and size of each business. For example, if you own a building and equipment, you're more likely to benefit from property insurance than would a business that's run from a home office, Podnos says.

"Insurance is to insure against the small chance of a large loss," he says. "There should be enough in coverage to replace the property owned by the business. If you have a home office and you don't have a business that incurs significant liability -- you're a psychologist, bookkeeper -- you can have very little coverage."

General liability insurance protects a business if a customer is injured on your property, while businesses whose employees frequently drive company-owned vehicles can benefit from commercial auto coverage. Business overhead expense insurance covers the operating expenses of your business in the event you become disabled, while key man insurance -- or insurance on the key person in a business -- covers the value of your ownership in the company.

Businesses that have significant professional liability, such as dentists and physicians, should be covered by errors and omissions insurance, commonly known as professional liability or malpractice insurance, Sander says. This type of insurance protects against alleged or actual negligence, legal defense costs and personal injury claims.

"You have to look at each business and say, 'What are the risks, what are the possible losses, and how do I best handle it?'" Podnos says.

Steve Nicastro is a staff writer at NerdWallet, a personal finance website. Email: Steven.N@nerdwallet.com. Twitter: @StevenNicastro.

To get more information about funding options and compare them for your small business, visit NerdWallet's small-business loans tool page. For free, personalized answers to questions about financing your business, visit the Small Business section of NerdWallet's Ask an Advisor page.

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