Small business

Preparing for Financial Challenges Your First Year in Business

frfrqfqrwfwqfMy colleague, Kalen Smith is a fellow entrepreneur and personal finance writer. Kalen went into business for himself eight years ago and recently admitted the first year didn’t go as smoothly as he planned.

“I passed up on several high-paying engineering jobs to start my own digital marketing business. It took me several months to start generating cash flow, which would have been virtually impossible without the financial support of my family. When I moved out and had to support myself, I quickly discovered the importance of proper budgeting and finding multiple streams of income.”

Most entrepreneurs have similar experiences. Being your own boss is very exciting. It can also be very stressful, especially in your first year when you were trying to generate a cash flow. A quarter of businesses don’t even last their first year. Even if you kept your day job, managing your finances can be overwhelming if your business is still losing money.

Sound budgeting and forecasting will make it easier to overcome your personal financial challenges. Here are some tips to follow.

Pay extra into your tax account during good months

First year entrepreneurs frequently overlook the reality of taxes. If you are lucky enough to turn a profit in your first year, you don’t want to be blindsided on Tax Day. Your taxes are going to be a lot higher when you are self-employed, because you will be responsible for both the employer and employee share of your federal payroll taxes. The self-employment tax alone will consume 15.3% of your income. Then you have to pay your income tax. If you generate a modest income, you will need to plan on paying at least 25% of it to the federal government alone.

I spoke with one business owner that didn’t set any money aside for his taxes during his first year in business. He thought he could pay at all on Tax Day, but discovered that his tax bill was $3000 more than what he had in his bank account. He had to put it on his credit card, which was obviously a costly decision.

Plan for taxes all year round. Always put your tax money into a separate bank account, so you don’t accidentally spend it. If you have a good month, you should pay 30% more into your tax account. This will give you a buffer for months that don’t go so well.

Don’t commit to costly life decisions after a good month or two

It is easy to feel overly optimistic or even cocky after a good month or two. You may feel that it is time to quit your job or upgrade to a more expensive apartment.

Having faith in the direction of your business is good, but don’t plan on every good month last. A bad month is always somewhere around the corner.

It is best to avoid making any expensive decisions until you have a solid income over at least a six-month period. Your income should be on track to exceed the pay of your old job by at least 50% before you going to business for yourself full-time.

Keep a six-month emergency reserve

Financial advisors typically recommend keeping a three-month emergency reserve in your bank account at all times. Here are some reasons you should save twice as much if you’re self-employed:

  • You won’t get paid leave in the event of an accident, illness or family emergency.
  • Your health insurance policy probably will have a higher deductible if anything happens to you.
  • You aren’t protected by the family and medical leave act. You could take a couple of months to get back on your feet after any problems arise. This doesn’t even factor for downturns in the business cycle.

Save enough money to address any of these problems in an emergency.

Look for Supplemental Income

You may not be able to count on the income from your business to get you through the year. It is a good idea to look for supplemental streams of income. You can try babysitting, selling old knickknacks on eBay or even taking surveys online.

Cut Back on Nonessentials

Being in business for yourself probably won’t be the glamorous lifestyle you expect, at least in the first year. Don’t expect to be drinking champagne or taking weekly trips to Acapulco. In fact, in your early years, you will probably need to live a more modest lifestyle than with your previous job.

This doesn’t mean that you need to sell your house and downgrade. However, you may need to stop buying all organic food or stop going out with your friends for drinks twice a week.

Try to figure out what you really need and limit yourself mostly to your essentials. You can splurge a little once in a while, but not to the extent that you did when you were working at your old job. View more frivolous purchases as things to work towards.

If you have any questions, please ask below!