[Recording] Financial Planning Basics for Entrepreneurs Part 1: Cash Flow Planning
This blog article is part one of a three-part series: Financial Planning Basics for Entrepreneurs. Part one focuses on cash flow planning for entrepreneurs. No matter what type of business owner you are—from freelancer to franchise owner—understanding the basics of financial planning can help you overcome the various obstacles you’ll face along your path to financial freedom.
For many entrepreneurs, cash flow planning is a challenge. This is especially true in your startup years, when revenue is unpredictable, and expenses are inevitable. In fact, 29% of failed startups point to cash flow problems as a central issue, according to data from the U.S. Bureau of Labor Statistics.
Moreover, lower paychecks also tend to come with the territory when you work for yourself. Based on recent PayScale data, 83% of small business owners take an annual salary of less than $100,000, and 30% reportedly take no salary at all.
The combination of these factors explains why financial planning is often more complex for entrepreneurs. The good news is you can still make smart financial decisions for your business, yourself and your family—even during times of uncertainty. In this article, we’re sharing a few key cash flow planning strategies business owners can implement to take control of your finances and reach new levels of success.
Cash Flow Planning Strategy #1: Create a Business Budget
A recent study by Clutch found that nearly two-thirds of small businesses (61%) did not create an official, formally documented budget for 2018. Notably, most businesses that reported not having a formal budget were smaller in size (1 to 10 employees). This is concerning, since having a budget can actually help you grow and scale your business faster.
The most successful business owners know exactly how much cash is coming into the business and how much is going out. When there are no guidelines around spending, a business can quickly run out of money.
A business budget not only informs spending, but it also reveals potential cash flow issues, which you can then fix before they become major problems. In other words, a budget guides your business towards profitability and away from potential bankruptcy. Whether you’re currently cash-flow-positive or not, creating a business budget is essential for successful cash flow planning.
Cash Flow Planning Strategy #2: Pay Yourself First
While budgeting is indeed necessary for the success of your business, it’s not always the answer when it comes to managing your personal finances. That doesn’t mean budgeting can’t work for you. It just means that very few people can successfully stick to a budget over the long term.
An alternative cash flow planning solution is to “pay yourself first.” In other words, since you’ve already created a business budget, you can make your personal income a line item under business expenses. That way you can ensure your personal financial obligations are met and balance your business budget at the same time.
To pay yourself first, calculate your personal financial liabilities, taxes, savings goals, and other necessary expenses for the year. This is the amount you’ll allocate to personal income in your business budget.
If you find yourself with a budget surplus at the end of the year—either in your business or personal finances—you can decide how to use that money most effectively. The goal of cash flow planning is simply to ensure cash flow remains positive—not to dictate every spending decision.
Cash Flow Planning Strategy #3: Planning for Unpredictable Income
One of the most common challenges entrepreneurs face when it comes to cash flow planning is unpredictable income. Sometimes your business doesn’t have the free cash flow to pay yourself as expected. However, to be able to consistently meet your personal financial obligations, you’ll need to project a reasonable income estimate for the year.
If your business is profitable and cash flow is relatively consistent, you can use your income from prior years to determine a reasonable range for what you expect to make each month. Then, compare this range to your projected expenses and savings targets. If the low end of the range covers your obligations, use this number for budgeting and cash flow planning.
On the other hand, some entrepreneurs are better served by coming up with an average monthly income. You can budget off of this number, and in months where your income is above average, save the extra cash to cover expenses in lower income months.
Again, the goal is to end the year cash positive, so it’s best to be conservative with your estimates to the extent possible. You can reinvest any cash that’s leftover at the end of the year back into your business or put it towards a personal financial goal.
Good Planning Is the Key to Success
Cash flow planning requires discipline, but the potential payoff is well worth it. If you’d like to develop a cash flow strategy with a financial planner, Oak Capital Advisors specializes in the personal financial planning needs of entrepreneurs. Please request a Free Retirement Assessment to get started.