For some people, starting a business may sound like a great new adventure.
Perhaps you’re no longer passionate about your current career path, or you want to trade in the 9-to-5 hustle for a job on your own terms. Or maybe you recently experienced a layoff and are looking for a fresh start.
Before you leap headfirst into your new venture, it’s important to make sure your finances are in top shape. Here are six tips to help you get started.
1. Plan for “rainy days”
Most experts recommend that families and individuals set aside an emergency fund equipped to cover three to six months’ worth of living expenses. If you’re starting a business, you should save double or triple this amount, aiming for 9 to 18 months’ worth of living expenses to cover the unexpected.
You should also consider having two separate cash reserves: one for personal emergencies, and one for business emergencies. In many cases, new entrepreneurs will experience a lull in cash flow until they start making a profit. Therefore, it’s a good idea to prepare in advance and set aside extra savings that can tide you over until your business takes off. You’ll also have peace of mind in knowing that you have a financial cushion to lean back on while trying to get your business up and running.
2. Seek out professional tax advice and identify the most suitable business structure
Before you open for business, consider enlisting the help of a qualified tax professional, particularly one who specializes in small businesses. Finances and taxes can be considerably more difficult to comprehend when you add a business into the picture, so having a professional on-hand to provide assistance can make your life a lot easier, especially as your business grows.
Additionally, there are many tax savings available to business owners, and an experienced professional will often know exactly what to look for so you can take advantage of those opportunities.
Certified public accountants are typically well-versed in the various types of business structures and can help you determine which one is the most advantageous for your enterprise. Sole proprietorships, partnerships and limited liability corporations are the most common structures for small and emerging businesses. Visit the IRS’s website to learn more about different types of business structures, as well as the income tax ramifications that come along with each structure.
3. Keep your business finances separate from your personal finances
Beyond emergency cash reserves, it’s important to keep all of your personal finances separate from your business finances. Maintaining a distinction between these two types of expenses will help reduce your personal liability; it’ll also help you better track and control your finances when it comes to paying bills, filing your tax returns and paying your taxes.
Separating your business finances from your personal finances is also essential in the event of a business sale, lawsuit or bankruptcy. Comingled personal and business accounts may nullify the protections you receive from your business structure.
4. Create a budget and track cash flow
It’s really important to have a budget in place for both your personal and business expenditures.
With a new business, your income will likely be variable (at least for a short period of time) so it’s important to have a plan in place. You also need to pay attention to the timing of your cash flow, which is just as important as the amount you have coming in. Be mindful of your cash inflow and outflow dates to ensure you’re able to keep your business and your personal finances running smoothly.
You may consider opening a line of credit for unexpected cash emergencies, such as late payments from a client or a vendor. That way, you’re always able to pay your bills and expenses in a timely matter.
5. Plan for life after your business
Now that you’re going into business on your own, you may not have a 401(k) plan in place — but that doesn’t mean you shouldn’t be putting dollars away for retirement. As an alternative, you may consider opening up and funding a Roth IRA. You can research and contact an investment advisor, a brokerage firm or a bank to help you start the process.
As your business grows, you may want to consider contributing to a SEP IRA or a solo 401(k) plan — two vehicles that can also allow you to shelter some of your business income from taxes.
Both a solo 401(k) plan and a SEP IRA can give you the opportunity to sock significantly more dollars away for retirement, compared to a traditional or Roth IRA.
For instance, in 2020 you can contribute up to lesser of 25% of compensation or $57,000 to a SEP IRA or to a solo 401(k) (between elective deferrals up to $19,500 plus employer contributions up to 25% of compensation). The maximum amount is increased to $63,500 for solo 401(k)s if you’re over 50, compared to a maximum of $6,000 for IRAs ($7,000 if you’re over 50).
As an entrepreneur, it’s important that you remember to pay yourself first; don’t tie up all of your assets in the business.
6. Have a risk management plan in place
Perhaps the biggest risk you can take when starting a business is failing to protect yourself. After all, this is a new venture, which means you are the most important element to its current and future success. Without proper coverage, you’re putting your entrepreneurial dreams at risk.
Make sure you have health, disability and life insurance policies in place to protect the company in case anything happens to you.
You may have a family at home, which means you’ll need to purchase policies to protect them, as well.
Consider seeking help from a financial advisor or insurance professional to determine how much coverage you should have to replace your income in the event that you are no longer able to work. As the business grows, your workforce will likely grow with it, which means you may need to consider additional coverage down the line. Click here to learn more about other types of business insurance.
This list isn’t entirely exhaustive, but it can help you start laying a solid financial foundation for your new venture.
Still have questions? Think about sitting down with a financial planner to help ensure that you and your family are better prepared for what lies ahead. Start planning today by contacting our advisory team.