You cannot just wing it as a business owner. Your livelihood is at risk here. You have to look at the numbers to ensure you are growing the right business for your life.
Here are the most important one’s to focus on.
For some, they look at profit as Revenue – expenses – compensation = profit
But with you being the only part of the business, the best way to look at it is revenue-expenses = profit.
Profit is what you can pay yourself unless you have to save for something. If you are saving for a building, new equipment, etc. then figure out how much you have to save to get there in the time period you need, and that is part of what you deduct and cannot pay yourself.
Some businesses choose to use the profit first method. The profit first method looks at it as revenue – profit = expenses. That is how much you can choose to spend on expenses. This can work great for some, but for others it can be tough. It’s a good goal to get to, but in the beginning may not be doable.
You have to understand what it costs to run your business. This is technology, contractors, equipment, licensing, marketing/advertising, etc. Go into it understanding this number really really well. It’s hard to know what to pay yourself without understanding your expenses.
You can use software like quickbooks or budgeting apps to track what’s going out. Don’t ignore your expenses! The goal is to run your business well while keeping expenses as low as you can. But don’t be cheap! Your product, service, marketing, etc. have to be worth it for customers to want to work with you.
Many service businesses have different levels of clients. It is important to understand how much you make per client so you can figure out who makes the most sense to work for. Oftentimes, people realize that 80% of their revenue comes from 20% of clients. This is good to know so as you grow you can focus on the most profitable clients.
Revenue is great, but if it takes 3-6 months to get paid, you can get into trouble fast. The truth is most businesses fail because they lack cash flow. This is why it can be so crucial to build a cash reserve just like you would with your own personal finances. You want to be able to weather whatever storm comes your way.
If you lack recurring revenue, you may want to have upwards of 12 months of expenses built up. If you have recurring revenue, you may be able to have a lower amount closer to 3-6 months. As you add employees and more expenses, a cash reserve becomes even more important.
Your yearly run rate is important for new business owners who are thinking of starting. I see so many people fail because they thought they would grow faster. The truth is it takes a lot of time.
The longer runway you can give yourself, the better chance you have to make it.
If you need $50,000 to live off of a year and it will cost $30,000 to run the business, you would want anywhere from $80,000-$160,000 saved to give yourself time to build this business and not be desperate and take the wrong clients just for some revenue.
The amount of business owners I have seen on a payment plan to the IRS is wild. You need to understand how much you will owe in taxes and save for it. If you are paying yourself $10,000 a month, you will need to save generally around 20-25% of that.
Work with a financial planner and CPA to ensure you are saving the correct amount for next year’s taxes. And if you are an S corp, set up quarterly tax payments so you don’t get stuck with any penalties.
Gross margin/gross profit reflects how much you have left when you subtract the cost of the product from the selling price. If it is super low, you will not have enough to cover everything.
Improving your gross profit margins is key.
This is what they always talk about on shark tank. If it costs $50 to get a client to buy a $40 shirt, you are in the red. However, if it costs that and the average customer comes back and buys 4 more shirts, you are looking good.
You have to understand the lifetime value of a customer and what they bring in so you can make key decisions on how to advertise. This will definitely take some time to get the data, but it is great to know if people come back or just use you one time. The deeper you understand your product, clients, lifetime value, etc. the better.
If you had to leverage credit cards, lines of credit, business loans, etc you need to know these numbers and the interest rates attached so you can come up with the best debt payoff plan for your business.
Leveraging debt can be wise for your business. You just have to do it well and have a plan to pay it off.
Many businesses take money early on to survive, most times this means you have given up equity. Make sure you keep track of this and know how much equity you own of your business.
According to entreprenuer.com, 98% of business owners do not know the value of their business. Yet, many business owners are keeping a large percentage of their wealth in their business. You have to check in and know the value of your business to be able to plan for your retirement. You have to know the multiples, whether it is sellable or not, for how much, etc.
As you go about building your business, have regular finance meetings to go over these numbers and ensure you are growing the right way!
If you need help managing your personal finances as well as your business, we are here to help! Book a free first meeting here (I currently have a waitlist till September right now).
Disclaimer: none of this is advice, it is just for informational purposes. Talk with your financial planner before implementing any of these strategies.
Financial Advisor