3 Things to Do Before Setting Financial Goals for Your Business
Setting a financial goal for your business? Do these 3 things (in this order) first:
Create a strong financial foundation for your business.
Understand how cash flows in and out of your business.
Determine your "enough” number.
Read on for how to get started with each of these steps, plus some pitfalls to avoid.
Create a strong financial foundation
The core elements of a strong financial foundation are:
Separating your business and personal finances.
Creating a simple process for tracking income and expenses.
Having professional support in place when you need it.
Separating finances. The best time to open a business bank account is just before you launch–the second best time is right now. A business-specific checking account with a debit card is the bare minimum, but you may want an associated savings account and/or credit card as well. Just make sure all the transactions that flow through those accounts are only related to your business.
When selecting a bank account, be aware of account fees, minimum balance requirements, & whether branches are located nearby for cash deposits or ATM access, if applicable.
Tracking income and expenses. There are many apps that help with tracking and categorizing income and expenses, and creating simple financial reports like a profit & loss, which shows your income and expenses over a specific timeframe.
You can use a spreadsheet to manage transactions, but I don’t recommend doing that. It’s error prone, manual rather than automated, and more difficult to generate reports (unless you’re a spreadsheet wizard, in which case, carry on!)
I use Quickbooks Online for my bookkeeping and financial reporting. It’s not perfect but it does what I need it to do. I also use it to send invoices, and some of my clients use it for inventory management and payroll.
Professional support. As solo business owners, we often have a DIY impulse out of necessity. But tax preparation and financial guidance should be outsourced to a professional who understands your industry and treats you with respect.
If you keep up your books throughout the year (or hire a bookkeeper to do it) and pay quarterly taxes, tax time shouldn’t be painful. A good accountant who likes working with small businesses and advises you well is an investment worth making.
Understand how cash flows in and out of your business
To get a handle on your cash flow, you need to:
Know all of your fixed costs.
Estimate your variable and unexpected costs.
Map out your income sources.
Fixed costs. These are expenses that remain the same whether you’re in a slow season or a busy one. Insurance, rent, utilities, loan repayments, & software subscriptions are good examples.
Since you need to pay these bills no matter what, you need to be aware of them and make sure you have enough cash on hand to cover them–even if you have to stop working for an extended period of time. This is when an emergency fund can be a lifesaver.
Variable and unexpected costs. Unlike fixed costs, variable costs do change in relation to how busy you are. Examples of this are purchasing inventory and/or raw materials, credit card transaction fees, and hourly wages for contractors or employees. If you had to stop doing business temporarily, these costs would also decrease or disappear.
Unexpected costs can be difficult to estimate, but you need to budget for some amount of monthly spend on all the random things that come up. These costs should have a place in your regular monthly budget, and shouldn’t come out of your emergency fund unless they truly are emergencies (or a large enough amount to qualify as an emergency.)
Income sources. Know how and when you're getting paid. Is your income from services, in-store/online sales, custom work, licensing, rentals, etc.? If you send invoices to your customers, what are the payment terms and timelines (ex. due upon receipt, or net 15/30/45 days)? What are the penalties for late payments?
Think about diversification opportunities for your revenue–if you provide services, are there products your customers would purchase from you? Do you have something available at several price points to serve customers with varying budgets? If you operate in a brick and mortar shop, can you also sell at pop-ups and markets (or vice versa)? Diversification creates resilience.
Determine your “enough” revenue number
There are three steps to figure out how much income your business truly needs:
Add up your fixed, variable, and estimated unexpected expenses.
Figure out what you need to pay yourself.
Understand your tax liabilities.
Baseline expenses. Knowing the sum of your expected business expenses is a fundamental calculation for business sustainability. If you find you're barely covering costs (or not consistently covering them) and feeling stressed about paying your bills month to month, now you're aware and empowered to seek out a solution. If you’re easily covering costs, keep reading to see what your “leftover” money needs to go towards.
Paying yourself. This is quite personal and depends on your individual and household financial needs, so you’ll need to look at your personal budget before identifying your income needs.
I sometimes see business owners underpaying themselves to make their business finances “work” but if your business isn't meeting your income requirements, it's important to figure out why and how to fix the issue. One benefit of working through these financial management steps is that you may find you’re able to pay yourself more than you have been.
Paying your taxes. If you’re operating as a sole proprietor or single-member LLC, expect that ~30% of your net income will go toward federal & state (if applicable) income taxes. Definitely ask your accountant to help you plan for this and set up quarterly tax payments. Paying taxes quarterly is not only required by the IRS, it’s also a great way to spread out your payments throughout the year so you can avoid a high tax bill in the spring.
With a strong foundation in place, a good handle on your cash flow & expenses, and a clear vision of your business’s income needs, you’ll have all the information you need to set realistic, fact-based financial goals on a monthly, quarterly, and annual basis.
Cover image from Unsplash.
