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Small business owners have two sets of finances to juggle: their business finances and their personal finances. Unfortunately, these two sets of financial goals don’t always align — such as if you’re reinvesting profits for growth while simultaneously trying to boost your savings.
On top of that, as a business owner, your personal finances are often more complicated than someone who’s a traditional employee, since you’re responsible for paying yourself.
Even though it’s easy to go full steam ahead on improving your business, you can’t let your personal finances fall by the wayside. Here are some tips for managing your personal finances as a small business owner.
#1. Seek Professional Help
The Ways To Wealth has gone from side hustle to full-time job to sizable business with a small team.
When I was employed and bringing in a consistent paycheck, I had my finances on autopilot. Bills got paid, there were automatic withdrawals into a 401(K) and IRAs, money was funneled into sub-savings accounts for short-term goals, and spending was consistent from month to month.
It took time and effort to get to this point, yet once I set up my systems, there wasn’t much to be done.
What I learned the hard way running a business is that managing business financials is an entirely different skill set than managing your own money. There are complex laws that need to be understood and followed, deadlines that need to be met and, hardest of all, forecasting that needs to be accurate.
Beyond that, you need to make sure you don’t get so bogged down in managing your business finances that it takes your attention away from actually growing your business.
This is why the best tip I can offer small business owners is to seek professional help.
Having the right financial team in place can save you a lot of time and stress, but it can also save you money.
To provide a personal example, I work with a CPA not only to file my taxes, but as a consultant throughout the year. This arrangement has paid for itself many times over, as I’ve been able to get personalized advice on aspects like what corporation status would save me the most money, the optimal retirement savings plan, and managing cash flow with regards to making sure I’m paying myself and my taxes on time.
At the same time, a CPA can only do so much.
Depending on your business, there’s a lot more to managing business financials effectively. There’s bookkeeping, record keeping, payroll, forecasting, industry-specific taxes, fees and preparing statements (just to name a few).
FinancePal is a company launched in 2015 that aims to take all this complex work off the shoulders of small business owners. By offering a full suite of services, including access to CPAs who understand your business at a very affordable cost, FinancePal essentially gives you a CFO who can work along with you to make sure you’re doing things not only the right way, but the optimal way.
As a small business owner, it’s your business that provides the fuel for your personal finances. If the business financials are not run properly, your individual finances will also be a mess. If you’re looking for a dedicated partner to help, click here to learn more about FinancePal.
#2. Choose the Right Business Structure
The law affords business owners several legal structures from which to choose — and each one offers different strengths and weaknesses. Choosing the right one can make a big impact on your bottom line.
If you have no employees, you aren’t required to set up a formal business structure. The sole proprietor designation is your default legal structure.
- Simplicity: There’s little extra paperwork and you don’t have to file annual reports.
- Cost: You don’t have to pay any filing or business registration fees.
- Taxes: You don’t pay corporate business taxes. You simply pay based on your personal tax rate.
- Lack of legal liability protection: Your personal assets may be eligible to fulfill any lawsuits in which you’re the defendant. In other words, courts could come for your home or car if you’re successfully sued.
- Raising funds: Lenders and investors alike prefer to see a formal business structure.
- Unprofessional perception: Without a legal structure, clients/customers may see you in a less professional light.
Limited Liability Corporations, or LLCs, offer benefits found in both sole proprietorship arrangements and corporations. LLC rules vary from state to state.
You can create an LLC as a sole proprietor for the extra protection, but they’re also useful for partnerships.
- Pass-through entity: Your business income flows through to your personal return, meaning no additional taxes on your business income first.
- Liability protection: Your liability in lawsuits and debts is limited to your LLC’s business assets.
- Management flexibility: There aren’t strict requirements on who can be involved in management.
- Piercing the corporate veil: In certain cases, a court can rule that your LLC protections don’t apply.
- Rules: LLC rules vary state by state, so you have to understand yours to stay compliant.
- Taxes: Some states apply franchise or capital values taxes to LLC income.
The C-corporation is the default IRS corporation classification you receive if you form a corporation.
- Raising capital: C-corps can issue stock, allowing them to raise a substantial amount of money. Investors generally prefer to invest in C-corps, too.
- Perpetual existence: The C-corp is a separate legal entity. Unless the corporation is closed down, it’ll continue to exist even after you die.
- Tax planning: C-corps may experience double taxation, but they also offer additional tax planning opportunities.
- Double taxation: C-corp profits are taxed at the corporate tax rate, then distributions to shareholders are taxed at each shareholder’s personal tax rate.
- Complexity: On top of filing articles of incorporation, C-corps must write corporate bylaws (and update them where necessary), elect a board of directors, and issue/track stock.
- Ongoing tasks: C-corps must hold board and shareholder meetings and provide periodic reports to shareholders.
S-corporation classification is a special type of tax status you can opt into by filling out Form 2553 with the IRS and meeting certain requirements after filing your articles of incorporation as either a C-corp or an LLC. S-corps receive different tax treatment under Subchapter S of IRC Chapter 1.
- Pass-through: S-corps do not experience double taxation as seen with C-corps.
- Not permanent: You can choose to shift to another business model by simply filing a written statement (signed by more than 50% of the shareholders) expressing your wishes to do so.
- Payment structure: S-corps must pay shareholders a salary and pay their payroll taxes if they’re employees — but these can be written off as business expenses.
- Requirements: The IRS restricts S-corp shareholder count to 100 and places other requirements on S-corps.
- Scrutiny: Because of the strict S-corp requirements, businesses with this designation are often subject to increased IRS scrutiny to ensure compliance. The IRS can remove the S-corp designation if your company isn’t compliant.
#3. Reduce Your Taxable Income
Business owners have several options for reducing their taxable income while saving for the future.
Just like employees, business owners can contribute $6,000 per year ($12,000 if married) to a traditional IRA and deduct that amount from their taxable income.
Health savings accounts are another great option. Contributions and growth are tax-deferred, and withdrawals made for qualifying medical expenses are tax-free.
As you can see, however, these options are limited on their own. You can cut your taxable income much further by supplementing these with business-owner-exclusive tax-advantaged accounts.
- Solo 401(K): Contribute the lesser of $61,000 in 2022 (plus $6,500 in catch-up contributions if you’re 50 or older) or 100% of your earned income.
- SEP IRA: Contribute the lesser of $61,000 in 2022 or up to 25% of compensation/net self-employment earnings, with a $285,000 compensation limit for calculating the contribution.
- SIMPLE IRA: Contribute $14,000 for 2022 (plus $3,000 in catch-up contributions if you’re 50 or older).
Now, each of these accounts has various rules and limits to keep in mind — especially if you have employees. A financial advisor can be a great help when picking the right account for you and determining how much to contribute.
#4. Take Advantage of the Tax Code
Retirement accounts are just one way the IRS affords you tax savings. There are plenty of other tactics. Let’s look at a few.
Carrybacks and Carryforwards
Many businesses show net operating losses (when certain deductible expenses exceed your taxable business income) in their first year or two, since they reinvest so much of their profits into deductible expenses.
These losses can be applied to previous years’ returns (carrybacks) or future returns (carryforwards).
In the case of a carryback, you can apply the net operating loss to your previous return to reduce tax liability and receive an immediate refund.
As for carryforwards, you can simply hold on to records of your NOL and apply them to your future return(s), reducing your tax liability. This is especially useful if you’re just breaking into your first year of profitability and want to cut your tax burden to increase your momentum.
As always, a tax accountant can help you figure out how to do this correctly.
Fully Expense Capital Goods
The IRS lets businesses fully expense certain capital goods upon purchase through Section 179 deductions, rather than spreading out those deductions over multiple years. This can offer an immediate and significant tax break to small businesses.
In general, vehicles, software, business equipment and machinery used at least 50% for business purposes are eligible for Section 179. You can only deduct the amount used for business purposes, though.
If you don’t or can’t fully expense certain capital goods, you can at least write off depreciation — but you can also deduct interest on most business loans and credit cards.
This allows you to borrow more funds for investment into your business. A decrease in your tax liability could offset a good chunk of that extra interest.
#5. Scrutinize the Cost of Services
Many business owners aren’t sure how much various professional services should cost, and they often don’t have time to do adequate research and shop around for multiple providers. A good number of service providers know this, and therefore try to charge the highest possible rates without sounding too absurd.
This can be especially challenging for services that don’t always have a clear return on investment, such as content writing and web design.
It may put a strain on your already busy schedule, but do your best to learn everything you can about a service before investing in it. Do some online research on relevant forums and keep track of pricing across several service providers.
If you find a firm or professional you’d like to move forward with, don’t be afraid to ask a lot of questions. They will provide you all the information you need to decide if they’re truly intent on getting your business.
#6. Stay in MVP Mode for as Long as Possible
Many small business owners invest capital in the wrong things, especially when they’re starting. They might hire an expensive web design agency to produce a best-in-class website or pay a graphic designer for a fancy logo. Regardless, many do this so their business looks “official.”
But none of these things directly make you profits. That comes from sales. In the early days of your business, you need to start small and invest only in what directly generates more profits.
Focus first on getting your minimum viable product/service — the bare minimum product/service necessary to gain customers and feedback — out into the market.
If you truly need a website, such as if you run an e-commerce store, keep it basic and low-cost. Use a platform like Shopify to build a store from scratch for only a few bucks.
Aside from that, though, focus on building your stream of leads and customers. Reinvest your profits into anything that you find to make more sales at a good return on investment.
Your sales may eventually slow down. At that point, you can slowly branch out into creating a more advanced website, getting a fancy logo, buying high-tech new equipment or other things.
#7. Expect the Unexpected
The global pandemic took tens of thousands of businesses by complete surprise. Despite stimulus bills and government loans, many businesses simply weren’t financially prepared and went under.
It brought to the forefront the importance of being prepared for the unexpected — but plenty of other events can catch you off guard and harm your profits.
- Changing market trends.
- Seasonality (even if you aren’t a “seasonal” business, changing seasons may affect areas like your supply chain).
- Economic downturn.
- Cargo ships getting stuck in the Suez Canal.
You can’t always predict what will impact your business, but you can be sure that there will be unexpected impacts.
So it’s important to consider what events might disrupt cash flows and profits, then create a plan to deal with each of them. Put aside enough funds to stay afloat, but no more than that. Otherwise, you may tie up cash that could otherwise be invested into profitable projects.
One idea to consider would be to get a business credit line. These let you access cash on demand, then pay it back when you can. You can use your credit line to hold your business over in case of short-term instability in sales or profits.
That said, if you get a credit line, avoid using it except for in emergencies. That way, you’ll avoid unnecessary interest and cut your chances of digging your business into debt.
As a small business owner, your business’s performance has a direct impact on your personal financial health. More profits generally means more take-home pay for you.
However, relying solely on making more money in your business won’t help you optimize your personal finances or make sure you’re on track towards your goals.
By following the tips laid out above, you can hopefully grow your business towards amazing success while ensuring your personal money goals are handled.