It is impossible to write about how you finance your business because every business is different. But there a few things about business income everyone should consider.
Keeping Track
Keeping track of your finances, income and outgoings, is paramount. This is where many businesses fail. You need to monitor your financial situation carefully because:
- It is not only unethical but illegal to continue to trade when you have no money, so it is a good idea to know how you’re doing and take action before your business fails
- You need to keep evidence for tax purposes. This is not only knowing your income and outgoings but proving your figures
- Management accounts are vital for all businesses, they help you see potential problems in advance.
- You need to keep track of money owed to you. This depends on how you organise your business but you should not lose track of fees and if possible get them paid in advance.
I keep my evidence in plastic pockets for each month and keep them in a ring binder for each tax year. Every month I enter my income and outgoings in a spreadsheet and use this to calculate my balance of income and expenditure.
My business is fairly simple and should my finances become more complex, I would pay an accountant to keep track and prepare a monthly cash flow. The cash flow can project likely trends and so help monitor overall performance. The accountant will advise me on further steps as my business grows.
Business Planning
It helps to have a financial plan for your business from day one. For small businesses this need not be elaborate:
- You need to understand how much money you need annually to cover business costs and drawings. Drawings are what you take out of your business to pay your household bills. You must distinguish business costs from drawings because business costs count towards tax relief. You’re taxed on profit and that is income less your business costs.
- You need to budget for your tax payments.
- Your overall costs, business plus household, gives you the minimum income you need to break even. This enables you to calculate how much business you need to do. Simply divide the average income per client or customer into your overall costs and the figure will be the number of clients you need in the year.
- This will help you understand your pricing. You may need to increase your prices to generate enough income from the clients or customers you can manage. Of course there are other factors, eg competition but you must know your basic figures before you take them into account.
Sources of Income
So, as a self-employed person, you need to work out where your income will come from to cover both business and household costs.
There are four main sources of income available to you. They all have their pros and cons and some are more important than others.
Earnings
This is the obvious one and the one that entails most work. Most of your work will focus on increasing earnings.
Beware this is not as straightforward as it may seem first. If you are self-employed you must do everything. This means your product or service is only one demand on your time. There are other things you need to do and pre-eminent among these is marketing.
If you’re excellent at what you do but can’t market it, then you do not have a business. You need to plan things so that you balance what you do with your marketing.
Let’s assume you have a service and can handle 6 clients at any one time. They pay upfront for a 6 month contract. If you have 6 clients at a given time, you’re living off the fees they have paid upfront for 6 months. If you don’t have time to market because you have 6 clients, you will have no new clients at the end of the 6 months. This can play havoc with your cash flows.
Also consider, if you do have time to market during that 6 months, what happens if you land a new client and don’t have space in your schedule for them?
The good news is this problem comes with success but don’t let success draw your attention away from your business, you need to work on it as well as in it.
Investments and Loans
If you can persuade someone to invest in your business you are in luck. You have something for which someone else is prepared to risk their income! The chances are they will not only offer financial support but also expertise. This needs to be agreed before you accept the money. Will they offer support?
It is worth agreeing in advance the type of support they will offer. Are they going to advise you or expect you to make changes to your business? If so, what is the nature of these changes? Their expertise may be really helpful but it is always better to be prepared.
If you don’t want someone who expects a say in your business in return for investment, you may be seeking a business loan. Loans are more arm’s length. Where an investment grows or shrinks with the business fortunes, loans are repaid to an agreed schedule with interest. Loaners demand interest irrespective of the business performance.
Grants and Other Support
Some ethical issues apply to grants and so they are not usually a source of income for businesses. They are generally available for social enterprises and so there is a temptation to become a social enterprise to qualify for grants.
There are generally two criteria for social enterprises; if either or both apply, you have a social enterprise.
It is a mutual or self-help group. This means a group of people work collaboratively to improve some aspect of their lives or community. So, a group of people who share a disability might work together on an enterprise that benefits their community.
The second is to have a charitable object, such as providing a service for people with a disability.
Sometimes businesses with no track record go down this route before they have a proven market. This may be more of an issue for the second type, the first type will be a group of people who clearly exist and will benefit themselves.
Funding bodies often focus on financial management and not so much on the effectiveness of the business. I have seen businesses receive awards for their planning whilst unable to show a market exists for their products or services.
The other issue is cash flow. A cash rich business can quickly spend its money if its focus is not on reaching its market. Front loading a business is not always the best way to approach it.
Savings
Savings support some businesses. Obviously, this cannot continue indefinitely but it is a way to get started.
The downside can be the business owner lacks urgency. They know they can keep going and hope that they’ll work it out in time to recover financially!
However, savings can be an advantage because they allow a business time to experiment. Many businesses fail because they run out of money and others fail because they run out of patience. If you have savings, you have independence to try things, learn from mistakes and so build a business on sound foundations.
Assets
By assets I mean anything you own that generates income. Assets cover things like stocks and shares, rental income, intellectual property and so on. Pensions may be included here although they come into play in later life. Assets do not include possessions such as your home, car or other things. These are really liabilities because most of them depreciate in value, add to your expenditure or both.
Some people add to their assets consistently during a lifetime of work because they understand assets allow financial independence. Anyone who has assets that cover their business and lifestyle costs are in an enviable position but they will be a small minority of the self-employed.
