Many people find themselves responding to the siren’s call of self-employment, wanting to be fully in-charge of their success or failure. It can be a heady thrill, submitting your resignation and taking those first steps into the unknown with grand expectations, but it can also come crashing down quickly if you aren’t prepared to transition financially from employee to business owner. Last Friday, I shared the benefits of having side hustle, which included turning a side job into a full-fledged business. Today, I have some tips to help you thrive financially when you decide to become your own boss, whether it’s full-time or part-time.
Many dream of being in charge, but owning your own business, whether it’s a one-man shop or you have multiple employees, is more than giving orders. I’ve worked with many small business owners and seen many thrive and some not. While there are certainly situations outside of our control that contribute to why one business succeeds or fizzles, we’re going to focus on a few, more tangible, basic steps that can help make your self-employment aspirations become dream fulfillment versus a financial nightmare.
How To Manage Your Personal and Business Finances when Self-Employed
Being a business owner is a lot like investing in the stock market: you must expect some volatility. These tips will help you stay afloat in rough times (which will happen) and truly thrive during the good times.
1. Budget for Fluctuating Income
The idea that earnings are not limited is one reason many people want to form their own business. The flip side is when your income fluctuates, it can be harder to budget appropriately. And let’s be real: your income will not consistently increase every single month for perpetuity. There will be an underperforming month or two or three. You need to adjust from a steady paycheck to a fluctuating income mindset.
Know Your Bare Bones Budget
This budget is essentially made up of your non-discretionary bills and expenses, such as mortgage/rent and food and trimmed of all fat. To figure out the minimum amount you need to earn monthly (after taxes), add up all your bills and expenses (exclude things like entertainment, gifts or clothes which are discretionary expenses, but do include things like food and gas). This is the budget you use during underperforming months and hopefully will rarely need to utilize.
Tip: Prioritize Your Bills and Expenses. While your intention is to earn enough to cover bills and expenses, there may be times when you don’t and your emergency fund is tapped out too. Therefore, you want to prioritize which bills to pay first, such as your mortgage over your cable bill.
Create Your Regular Monthly Budget
This budget combines both non-discretionary and discretionary bills and expenses. It is likely close to the budget you used prior to self-employment, but may include some additional expenses, like higher health insurance bills if you were previously covered under your employer’s plan. As always, regularly review to make sure there is no fat to trim or other adjustments needed.
Maintain a Separate Business Budget
One mistake I commonly see with new business owners is that they don’t always separate business and personal expenses. It may seem unnecessary initially, but it actually makes things much easier, especially at tax time. While you can deduct business-related expenses, it does not mean you can spend mindlessly and don’t need to follow a budget. Avoid adopting an attitude where every business expense is a good expense. Otherwise, mindless spending, without thought to your bottom-line, will eat up all of your profits.
2. Build an Aggressive Emergency Fund
Emergency funds are must-haves for everyone, period. However, they become even more important to the self-employed. Due to income fluctuations, you may need to dip into your emergency fund more frequently than someone who has a consistent income and not always on what you typically perceived as an emergency previously, such as an unexpected home repair. A slow month may require you to pay your mortgage or your child’s piano lessons or buy groceries with your emergency fund. I recommend building an emergency fund to cover between 6-12 months of expenses.
Tip: Consider a Business Emergency Fund. Businesses have bills and unexpected expenses too. Take a look at your operating costs and set aside 3-12 months of expenses to help you stay afloat during slow periods, take advantage of opportunities and avoid using your personal emergency fund to cover business expenses.
3. Understand Your Tax Liability
Another common mistake I see is that people forget about Uncle Sam because they were used to taxes being taken out automatically from their paycheck. He, on the other hand, does not forget about you or the taxes you owe him. Work with your accountant to understand your tax liability and identify strategies that can help reduce your tax bill. You don’t want to get an unexpected tax bill that you cannot afford, which happens more often than you may realize. Your accountant can help break down what you owe and make sure payments are sent to the IRS in a timely fashion (typically quarterly).
Don’t Go Overboard with Business Expenses
One phrase I hear regularly is, “I can deduct it!”, which is true with most business-related expenses. It is a nice benefit but it is not an excuse to spend mindlessly. Every business expense needs to be carefully thought it and instrumental to the success of your business. Don’t forget — most businesses fail because they overextend themselves before they turn profitable. All the tax breaks in the world can’t help you if you spend more than your business can sustain.
Tip: Create a System to Track Business Expenses. Don’t throw away receipts because you will need them to file taxes and if you get audited. Figure out a system to organize receipts during the year and to store them after you file taxes.
4. Protect Business and Family with Proper Insurance Coverage
In some circumstances, if your spouse has coverage through their employer, you can be added to their health insurance policies. Other times, you will need to obtain health insurance on your own. Before you take the leap into self-employment, understand what coverage you will have to replace (health, dental and maybe life insurance and disability if you had employee plans) and what the cost will be. Even if you can be added to your spouse’s health and dental plans, know how it will affect their paycheck. Typically, their premiums will increase, leading to a smaller paycheck, which may mean making some tweaks to your budget.
What Insurance Does Your Business Need? This depends on the type of business you own, whether you have employees and more. Insurance is also something many new small business owners overlook until a problem arises, which can sometimes be too late. To understand the different types of insurance related to owning a business, go here and your financial advisor and/or accountant can also help determine what coverage you may want to consider.
5. Continue Funding Your Retirement and Other Goals
Business owners wear lots of different hats and sometimes priorities shift. Some put retirement and other goals on the back burner while they get their business off the ground. At the same time, I encourage you not to ignore them or to stop saving/investing in your goals either. While you certainly want to create a sustainable business, you still want to retire eventually and achieve many of your other goals, like paying for your children’s college education.
It’s important to balance priorities, both personal and business-related, so you can make informed decisions. You can mindfully choose to reduce how much you save for retirement or temporarily stop funding certain goals, but do so with the full knowledge of the effect on your goals. Business ownership may be a goal of yours, but you likely have other goals too. Prioritize and plan carefully, so you can live that rich, fulfilling life you desire.
Tip: Think Percentage, Not Dollars. When it comes to paying your quarterly taxes or funding goals, figure out the percentage you need to set aside. This will help ensure that you don’t shortchange yourself whether you’re collecting a $5 payment or $5,000.
Be a Money Smart Business Owner
When many people think about starting their own business, they naturally think about the product and/or service they are going to offer. While there is no doubt that having the right product/service is instrumental to success, many businesses have failed even though they offered a highly desirable product/service that filled their clients’ needs. Their downfall was not being able to manage their money wisely as a business owner. These five steps will get you started on the right path.
Are you self-employed or plan to launch your own business in the future? How are you preparing? What has been the best financial advice to help you succeed with your business?
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