Whether you are starting a business from scratch or you’ve been in business for a while, getting a firm handle on your business finances is the key to successfully building wealth with your business.
As a business owner, it's easy to get busy and caught up in the day-to-day running of your business. But you don’t want to let your finances fall to the side. It's important to stay on top of the financial health of your business.
In this article, we'll go over key tips to manage your business finances, how to create a business budget, and costly mistakes to avoid. With that being said, let's get started!
Tips to manage business finances
Below are key tips you can leverage to help you track and manage your money better as a small business owner.
1. Open a business bank account
To accurately track your business finances and avoid any issues ( e.g. IRS issues, financial tracking, and forecasting inaccuracies) you need to completely separate your personal finances from your business finances ASAP. This means opening a business bank account. If you need to take out funds from your business for personal use, plan to pay yourself a salary (e.g. weekly, bi-weekly, monthly) so the withdrawals can be tracked properly.
2. Review your business structure
Most business owners start out as sole proprietors. But as your business grows and becomes profitable, you should consider transitioning your business structure into an LLC (Limited Liability Corporation). You could also consider an S-Corporation or a C-Corporation if those business entities better suit your needs. This allows for full separation between your business finances and personal assets in the event of a liability issue. For instance, if a customer sues you. These types of business structures can provide you with a certain level of protection for your personal assets. They can also have certain tax advantages.
3. Get organized
If you want to build wealth with your business, you need to be organized. This means creating systems to track your business finances. Specifically, you should track transactions, financial documents, accounts, and more. There are several business finance apps that you can leverage to start getting your finances organized. Examples include waveapps.com, quickbooks.com. Being (and staying!) organized will save you a ton of time.
4. Get an accountant
An accountant can provide you with certain insights when it comes to your business finances. He or she can also help with your business tax filings, which can be a complex undertaking. One thing to keep in mind, though, is that if you decide to hire an accountant, you still need to be involved in what's going on with your business finances. So plan to schedule frequent meetings to discuss the state of things in your business with them.
5. Create a business emergency account
A business emergency account is to your business what your personal emergency account is to your personal life. It can help provide you with a backup or buffer in the event of unplanned business circumstances. For instance, covering payroll during a slow season, replacing a damaged sales order, or making unplanned but required purchases.
6. Create an account to save for taxes
If you are making money in your business, then you will most likely have taxes to pay. Instead of letting your tax bill surprise you at the end of the year, start planning ahead. Create a business savings account specifically for your tax savings. This is where you put away a certain amount (~30%) toward your end-of-year tax bill. Or, you can pay your taxes quarterly.
7. Create a business budget
Your business budget allows you to manage your business finances properly and stay on top of your expenses. It’s essential for making financial forecasts for your business and becoming profitable. A budget helps you lay out your income and expenses (budgeted and actuals) and helps you get a clear picture of how your business is doing financially.
8. Pay yourself a salary from your business the right way
Before you pay yourself a salary, make sure your business will remain afloat. This means making sure that your operating expenses are paid first (including your tax estimates).
You should be tracking your monthly business operating expenses in your business budget. For the most part, a lot of your operating expenses, like rent, website hosting, and salaries, will be fixed each month. But when it comes to your variable expenses, you'll have to make estimates based on what you know is coming up.
After you have paid your operating expenses, you can take what you have leftover from your business earnings in that given month and break things out into percentages. Consider the following:
- Emergency fund: 10%. Ideally, you want to have at least 6 months of business expenses available in this account to help weather a business decline
- Profits: 10%. You should have plans to make distributions to yourself (and employees) as a bonus every year.
- Estimated taxes: 20%. This way you are not overwhelmed with figuring out how to come up with funds to pay a large tax bill.
- Reinvestment: 30%. Put this amount back into your business to put toward operating expenses, new projects, marketing, branding, and other business needs to keep your business growing.
- Your salary: 30%. This percentage is just a guideline. Be sure to take into consideration how well your business is doing to determine when and how much to take as a salary. As you pay yourself, don't forget to start saving for retirement. There are several different self-employed retirement plans and savings strategies.
9. Get insurance
Having business insurance is critical. From error and omissions insurance to property insurance, it is really important to protect yourself from the cost of client suits or property loss or damage. It’s a good idea to sit with an insurance broker to discuss your business type and get recommendations on the best type of insurance you should have. No one wants to have a circumstance occur that will require insurance, but things happen and it’s better to be protected than sorry.
10. Avoid credit card debt
Just because you can qualify for a business credit card doesn’t mean you should get your business into debt. Use your budget to plan out your business finances and if you do use a credit card for your business activities, plan to pay off your balance in full each month.
Creating a business budget
When you think about creating a business budget, you may start thinking, "This is going to get complicated.” But it really doesn't have to be that complicated at all! As a small business owner, the biggest things you want to track are your income and your expenses. Then determine each month whether your expenses exceed your income based on your actuals and why.
I'd recommend you create your budget using a spreadsheet. In it, list out all of your business expenses and what you expect them to be each month. Keep in mind you will have two types of expenses.
1. Fixed expenses
These are the expenses that stay the same each month and do not change from month to month.
2. Variable expenses
These are the expenses that change from month to month depending on different factors. For instance production costs, shipping costs, etc. It’s okay to estimate your variable expenses based on what you think they will be.
You also want to list out all the possible ways you will earn money and how much you expect that income to be each month. Once you’ve listed out your expected expenses and expected income, you basically have your budget in place. You then want to make sure you include room to track your actuals based on your budget for that month.
Keep in mind that it’s a really good idea to lay this all out so you fully understand your business's financial picture. The good news is, it costs you nothing to do this on your own. There are also several paid cloud accounting tools out there that can help you as your business grows. And of course, there's my automated Excel spreadsheet tool to help you out too!
How often do I need to create and track my business budget?
You should plan to create a budget for your business each month (or several months in advance). Then, track your actuals against the budget you’ve created. Take note of any variances or reasons why your budget came in over or under.
Tip: Your budget helps you plan what to expect in terms of your income and your expenses. In a sense, this is a way of doing simple, short-term financial forecasting. So let’s say you create a business budget for the next 3 months. You now have a 3-month money forecast in place for your business in terms of what your expenses and expected income will be.
Financial mistakes to avoid as a business owner
Now you know what it takes to build a financially savvy business. Now, let’s look at some common mistakes first-time business owners make. Hopefully, being aware of these pitfalls will prevent you from falling victim. The mistakes I mention below can easily be avoided with smart decision making and good planning. Avoiding them could potentially save you thousands of dollars. So here goes!
Mistake #1: Overestimating how quickly you’ll earn a profit
A lot of business owners assume they’ll launch their businesses and with weeks they will have a profitable business. That is rarely the case. In fact, it takes time to build a stable and consistently profitable business. Make sure to build that into any plans you have. Especially plans you make around paying your bills.
If you are currently supporting your business by working full or part-time, don’t quit your job right away! First, perform a break-even analysis so you can estimate how soon you can expect to start earning a profit (assuming all goes as planned).
Mistake #2: Mixing personal and business funds
Mixing your personal and business funds is a big no-no. For one thing, it is a tax time nightmare! It will be nearly impossible to make business deductions based on your business profit or loss. Not only that, you’ll have no way of knowing how much your business is actually making or losing. That means you have no idea how your business is doing financially.
Also, if you were to ever need to apply for a business loan, you would have to show your business financials over time. If your personal and business finances are mixed, you would have no way to show this.
Mistake #3: Not staying on top of bookkeeping
Bookkeeping is time consuming and annoying. I get it. However, a lot of business owners lose tons of money by ignoring their bookkeeping. As a business owner, it’s something you just have to do. And doing it frequently makes it easier. Put a couple of hours on your calendar once a week or bi-weekly to review your expenses and stay on top of your invoices. There are lots of tools that can help make the process easier, or you can create your own simple spreadsheet.
Mistake #4: Not planning for taxes
As a small business owner, it’s really important you plan for taxes. If you own a profitable business, you need to plan to put funds aside to pay the taxes you will owe the government. If you are not yet profitable, then you might be eligible for certain deductions based on your business expenses. Either way, you want to make sure you are prepared for taxes. Your accountant can help you plan for this.
Mistake #5: Not hiring a good accountant
Speaking of which, a good accountant is really important in your small business. Not only will they help file your taxes, but they will also provide you with recommendations that can save your business money and keep you up-to-date with the latest tax laws. In addition, they can help you handle payroll, help you prepare annual statements and documentation to support getting financing, and much more. Perhaps most importantly, your accountant will assist in the event you ever get audited. Having an accountant is essential to your business finances.
Mistake #6: Not hiring a good lawyer
A good lawyer that handles small business matters is really important in your small business. Your lawyer can help you with ensuring your business is properly registered and structured.
They can help you review all of your contracts and legal documentation like possible partnerships, vendor and client contracts, or any trademarks you may want to create. And if you were to get into any disputes with vendors or clients, they can give you legal advice and represent you if need be.
Both your accountant and lawyer will save you valuable time and give you the peace of mind to know that things have been done the right way.
Mistake #7: Not establishing a business emergency fund
Your business emergency fund should be able to cover your business expenses and keep you running for at least 3 to 6 months without you having to incur new or additional debt. There are folks out there that would tell you to get a business loan in the event of an emergency. But I’m of the opinion that if you are currently running a profitable business, you should create your own cash cushion for your business in the event of emergencies and grow it as the business grows.
Mistake #8: Not having business insurance
Business insurance is essential. Not having business insurance is a huge mistake many business owners make. And this can directly impact your business finances. Imagine if your computer gets stolen, or if your retail store gets vandalized and you don’t have insurance? You are solely responsible for the replacement expenses. It’s worth making a phone call to an insurance agent to discuss the various types of insurance available for your business type.
Mistake #9: Getting into business debt without a plan
A lot of times business owners take on business debt in the form of credit cards or business loans. These can be either from family and friends or a bank. And many do this without a solid plan for how these funds will be used in their business or how they will pay back this debt.
They get sidetracked and then start spending the funds on stuff that is “nice to have” because they don’t really have a plan for the money. It is essential that before you consider any business funding that involves acquiring debt, you carefully plan out how the funds will be allocated. Then, make a plan to repay back the debt as quickly as possible.
If you follow these tips and are able to avoid these money mistakes, you will be setting a solid foundation for your business finances and in turn, your overall success. At the end of the day, outside of the passion you have for your business, I'm sure you want to make (and keep!) your money!