My last article addressed the cashflow and tax consequences of not being smart about drawing a regular income from your business. Check it out here.
This topic is by far the most popular out of the many articles I’ve written and so I’ve revisited to share a framework based on some of the small business owners I’ve been speaking with and some of the comments and feedback received.
In fact when engaging new business clients this very issue is one that gets reviewed straight off the bat. So how do I best advise small business owners to maximise cashflow, minimise tax and draw a wage all at the same time?
Just as you personally need cash to put food on the table and pay the bills, your business also needs a healthy supply of cash to keep the cogs ticking. If you then want to invest personally say in property or shares you need surplus cash on top of everything. Similar, if you want to grow your business through marketing, opening a new shop front, rehashing your website or maybe taking on a new team member, your business needs surplus cash to make this happen.
If you have a cashflow forecast for your business, which is a seriously undervalued report for small business owners, you’ll see the expected peaks and troughs and gain an understanding of the “free cashflow” your business has. This also includes accounting for things like quarterly/monthly BAS payments, quarterly superannuation, annual income tax and debt repayments which often businesses don’t have funds aside to service.
You should start by drafting a personal budget on a per month basis of what you need to pay yourself to put food on the table. Most people are creatures of habit so your groceries, meal, fuel, insurance, entertainment etc. should be fairly predictable. Or at least start then tweak along the way. This now provides the minimum amount you need to regularly draw from the business.
A safe practice for most businesses is to build 3 months worth expenses aside as a contingency plan (just in case you know what hits the fan). This same philosophy can be adopted on a personal level with 3 months worth of living expenses put aside. I’m not a financial planner so I’d suggest you speak with your advisor to best guide you on personal cashflow and budgeting practices.
This might take some time to achieve especially those businesses running on a shoe string budget. The point is to start even if it’s only small.
Once your business has surplus funds aside and you personally have a buffer then anything additional in the business can be allocated to help you towards your goals. If you want to grow your business you need to invest in a bigger team, marketing, infrastructure and advisors. If you want to build personal wealth or perhaps take a long overdue holiday then you might allocate some funds.
Your also now better positioned to approach a bank or investors to prop up any additional cash you need as opposed to you personally having to keep contributing out of your pocket to keep the business alive.
Remember, most people spend more time planning their holiday than they do planning their business. In some businesses, say the building trade, cashflow is very lumpy and you need to be all over your cashflow like a hawk or consider something like an overdraft to dip into when you’re waiting for a slow payer or another draw-down on a build.
In summary you personally need cash to live but so does the business so for small business owners and those getting started to will be a careful balancing act to ensure you don’t starve the business of the lifeblood it needs to grow.