As with any small business, cash flow is the lifeblood of your therapy practice. An emergency fund—also called rainy day savings or retained earnings—guarantees that cash keeps flowing and you can keep operating in the event your revenue drops.

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But creating an emergency fund for your therapy practice isn’t just about preparing for the worst. For instance, if your practice suddenly takes off and you’re hit with a tidal wave of new clients, you might dip into your emergency fund to hire a virtual assistant who can help you manage your caseload.

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If you don’t have one yet, the best thing you can do is start building up an emergency fund now. Here’s where to begin, and how to make the most of your savings.

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What is an emergency fund for?

The purpose of an emergency fund is more or less self-explanatory. It funds your business in case of emergencies.

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For a small therapy practice, you might use your emergency fund in the event of:

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• A temporary business closure because of illness or injury
• An economic downturn during which fewer people seek private pay therapy
• A reduction in caseload as you transition your practice from insurance to cash pay
• Events like utilities outages, natural disasters, pandemics, or civil unrest, which could prevent you seeing clients
• The temporary loss of office space if you are unable to renew your lease
• Legal expenses not covered by professional liability insurance
• The loss of clinicians from a group practice (particularly if clinicians leave and take their clients with them)
• The need to hire an administrative assistant to help manage an increased caseload
• Hiring a bookkeeper or an accountant to manage your finances because business has suddenly picked up and you don’t have time to do it yourself
• Loss or damage to equipment like computers, printers, or office furniture

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Keep in mind that an unexpected expense does not need to be large in order to justify using your emergency fund. If your budget is tight, even a relatively small expense—like replacing an office printer—may be difficult to cover if you haven’t accounted for the expense in advance.

Alternatives to an emergency fund

One important reason for creating an emergency fund is that to do so is better than relying on an alternative.

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If you don’t have an emergency fund but you need to cover unforeseen expenses, you may find yourself relying on a business credit card or using a line of credit. Both these options mean going into debt. The result? Interest fees, possible damage to your credit score, and a higher debt-to-income ratio.

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Some business owners opt instead to use personal funds to cover themselves in case of emergency. But this can set you back in your goals for personal saving, and may make your personal finances harder to plan. And depending on your business structure, it could pierce the corporate veil, preventing you from enjoying the liability protection a registered limited liability company (LLC) enjoys.

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In all cases, setting aside money for an emergency fund now is preferable to borrowing money or dipping into your own reserves later.

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How much should you save in an emergency fund for your therapy practice?

As a general guideline, plan to save up enough cash in your emergency fund to cover three to six months’ operating expenses.

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Your operating expenses are the expenses you pay in order to keep your therapy practice running. They include: 

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• Rent
• Utilities
• Insurance
• Subscriptions (eg. for an electronic health records (EHR) platform)
• Website hosting and directory listings
• Continuing education

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In this case, three months’ worth of operating expenses should be the minimum goal for your emergency fund. With that, you can keep your practice operating for three months with zero revenue.

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But the more funds you set aside, the more secure—and better prepared—you will be.

How to calculate the right amount to save

To calculate average monthly operating expenses:

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1. Add up your total operating expenses for the past 12 months. (Alternatively, you can use your end-of-year profit and loss statement (P&L) for the prior year.)
2. Divide that amount by twelve to get your monthly expenses.
3. Multiply your monthly expenses by three.

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The result is the total amount you need in order to keep your practice running for three months without revenue.

How to build up an emergency fund

There are three strategies for building up an emergency fund for your therapy practice:

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1. The 10% guideline
2. The 80% guideline
3. Monthly installments

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The one you choose depends on your financial situation, debt load, and preferred method of saving.

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The 10% guideline

An old rule of thumb says that you should set aside 10% of your annual revenue in an emergency fund.

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The benefit of this approach is that it’s easy to calculate how much to set aside each month. For instance, if your revenue is $8,000, you put aside $800 in your fund.

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This approach may not work if you have considerable debt to pay down. On the other hand, if you can afford it, you may prefer to make larger contributions to your fund as it’s just getting started, and only switch to saving 10% once you reach a certain benchmark.

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The 80/20 guideline

The 80/20 guideline is meant for businesses with monthly debt payments. Because of interest fees, you may decide those payments should take priority over building up an emergency fund.

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With this approach, each month you:

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1. Pay yourself a minimum salary or owner’s draw (enough to cover living expenses)
2. Calculate your profits (money earned after covering operating expenses)
3. Spend 80% of your profits on paying down debt and put the remaining 20% in your emergency fund

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This method helps you to get out of debt while still guaranteeing a portion of your profits is saved for a rainy day.

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Monthly installments

With the monthly installments approach, you set a goal for how much you would like to save in your emergency fund, then create a timeline for reaching that goal.

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Then, you make the monthly payments necessary to reach that goal on time.

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Here’s an example: your monthly operating expenses are $2,000, and you want to set aside enough emergency funds to cover three months. That’s $6,000 total. You settle on a 12 month plan to reach your goal. Since $2,000 divided by 12 is $500, you should plan to set aside $500 each month in your emergency fund.

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The benefit of this approach is that it gives you a clear goal to aim for, which can make building up an emergency fund more rewarding. It also guarantees that, at a certain, defined point, you will have enough funds to cover you in case of an emergency.

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The downside is that it does not account for fluctuations in income. If your income varies considerably from one month to the next, you may find it easy to pay your emergency fund installment in some months and not so easy in others. 

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If you start off with an installment plan but find you can’t keep up with payments, it may mean you need to set a more realistic timeline. 

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When is the right time to spend emergency funds?

As your emergency fund grows, you may occasionally be tempted to dip into it to help cover day-to-day expenses. Writing down guidelines to how the fund should be used makes it easier to avoid temptation and ensures you only use your emergency fund how it is meant to be used.

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The exact guidelines you follow will depend on your needs and the needs of your business. But consider including:

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• Revenue drop limits. You will only use the emergency fund if your revenue for the month drops a specified amount or percentage. 
• Expense limits. You will only use the emergency fund to cover expenses greater than a specified amount.
• Trigger events. You may want to list specific events—like a prolonged absence from work—that trigger the use of your emergency fund.
• Reporting. Under which account does emergency fund spending appear in your general ledger? What additional steps do you need to follow to track how the funds are used?
• Replenishment. Consider making a plan to increase emergency fund contributions in the short term after you are forced to withdraw money as a means of replenishing the account.

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Where should you keep your emergency fund? 

Keep your emergency fund in a long-term savings account separate from your other day-to-day business spending accounts. Choose an account that bears the highest interest possible. It may be years before you are forced to use your emergency fund. During that period, an interest-bearing account helps your funds to keep pace with inflation.

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You may also consider putting a portion of your funds into a Certificate of Deposit (CD). A CD bears more interest than a savings account. It does so over a fixed period during which you do not withdraw the funds.

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If you go this route, shop around to find a CD that will not penalize you for withdrawing funds early. In the event of an emergency, you may need to withdraw funds before the CD period is complete. If doing so triggers a penalty, that penalty could effectively wipe out any interest on your savings you’ve managed to accrue.

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Can you start an emergency fund even if you are in debt?

You can start an emergency fund and grow your savings even if your therapy practice is in debt. The important thing is to make sure that you are managing to pay down some of your debt each month while still making deposits in your fund.

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That may mean you only make small contributions at first. But putting $100 into an emergency fund each month is better than making no contributions at all. Even a small emergency fund can make a difference when you really need it. And getting started now helps you get in the habit of always having an emergency fund on hand.

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For help, check out How to Pay Off Debt: A Complete Guide for Therapists.

Key takeaways

• An emergency fund is essential for helping you cover operating costs in the event of unexpected expenses or a dip in revenue

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• By having savings on hand, you can avoid using your credit card or taking out a line of credit and increasing your debt load in the event of an emergency

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• Make a plan to contribute a portion of each month’s income or revenue to your emergency fund

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• Set clear guidelines for how you will use and replenish your fund—this can help you resist the temptation to dip into it to cover everyday expenses

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• Keep your emergency fund in a high-interest savings account; you may also put a portion of it in a CD that does not charge early withdrawal penalties

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• You can start building up an emergency fund even as your practice pays off debt; even small contributions to an emergency fund now may prove helpful later on 

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Planning ahead for your private practice? Check out our guide on how to build a budget for your therapy practice.

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This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post.

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Bryce Warnes is a West Coast writer specializing in small business finances.

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