One of the biggest reasons why businesses fail is not due to a lack of great ideas, innovation, or even implementation. It’s because of financing. A lack of proper financial structure can be devastating to a business. As you may or may not already know, we are advocates for purposeful bank accounts. We wrote a blog on how to intentionally structure your personal bank accounts. We do the same for our business accounts. Today I am going to share with you how to structure your business bank accounts so you don’t become another failing business statistic. You are a boss at your business. Make sure your finances reflect that too.
First off, I have to give much credit to how we advise on business banking structure to Mike Michalowicz, author of Profit First. If you like what you read in this blog today, the next best step is to buy his book. It will give you the details I’m leaving out.
We advise quite a few business owners. In our experience, we see two major forms of struggle: consistent owner pay and lack of tax preparation. Gone are the days of W2 employment. Biweekly paychecks and automatic tax withholding are like fairy tales to us entrepreneurs. Today I’m going to show you how to make those fairy tales a reality.
There are 6 bank accounts you will need to structure this system. If you don’t bank with an institution that freely allows you to create separate checking accounts, then in the wise words of @lukefranchina: dump his a$$. The 6 accounts you will create are:
Y’all know the importance of an emergency fund for your household. It’s no different for your business. How long can your business stay afloat without earning any money? What expenses do you need to keep paying (rent, employee pay, software, etc) even if one dollar doesn’t come through this month? Just like with your personal savings, your business savings should incorporate a sleep-at-night factor. Maybe you run a consulting business with very little overhead. Therefore, you only need about $3k-$5k to keep up with your expenses for 3 months. If that doesn’t give you confidence, raise it!
Hot Tip: Don’t save for your own wage in this bucket. If you start a business, it *should* mean that your personal finances are in tip-top shape. Therefore, the emergency fund you have in your personal savings should be built around the income you bring into your household. If your business dries up for a few months, you will use the business savings for business expenses, and your personal savings for your personal income needs. If you need help calculating your appropriate savings balance, send us an email at email@example.com.
This account is the gateway to your business’s financial foundation. Every sale or dollar that comes to you is deposited into this one account. From here, you will distribute money into the four remaining accounts. Once you distribute all of your dollars to the other accounts (I suggest doing this at least monthly), this account should fall back to $0.
As mentioned above, we see too many entrepreneurs fail to prepare for tax payments. This system avoids that. Each time you transfer dollars from your Revenue account, you will take a certain percentage and allocated it towards your Tax account. This account is used ONLY for tax payments, nothing else. Think of it this way, these dollars aren’t yours, they’re Uncle Sam’s.
Don’t get caught up in the minor details of this, that’s your accountant’s/bookkeeper’s job. Your job is to simply assign a percentage of your revenue dollars to be deposited into this account. When your accountant tells you to pay $xx amount for taxes, you already have a bucket set aside to do just that. No more surprises. No more anxiety about having enough for tax payments. Taa daaaa!
You’ll notice below the percentage to set aside is only 15% of revenue. That may seem low to people who experience 20-35%+ tax brackets. However, the percentage is based on gross revenue. You won’t pay tax on all of those dollars since some are used for business expenses. That’s why this nice round 15% figure works!
Hot Tip: This bucket should pay both your business taxes and your personal income taxes as a business owner!
There are two types of expenses you have to face as a business owner: fixed and variable. I can’t stress enough how important it is to know which expense falls under which category. After all, it’s your fixed expenses that you will primarily base your savings balance on. Today is not the day for me to describe what’s appropriate to spend your business dollars on. Instead, I want to provide you with the guardrails.
Your expenses need to be limited. Assigning a percentage to how much you can spend is a great way to make sure you don’t spend your way to a failed business. As your revenue grows, your expenses will also naturally increase due to the nature of this system.
For this account to work successfully, you need every single expense to come from this account. Remember, your funding it each month by transferring dollars from the Revenue account into the Expense account. Then expenses are automatically withdrawn from this account and this account only. If you have a business credit card (only recommended to those who have nailed this system down first), then your business credit card is paid off from the dollars within this account.
Hot Tip: This is more of an observation than a tip. We have this tendency as business owners (I am certainly not free from this) to say, “I’ll just expense it!” It gives us this naive perception that an expense is somehow free. That attitude can lead to excessive business spending which essentially wipes out any potential “tax savings.” David Rose knows this well.
You have got to start paying yourself consistently. This will benefit your business and your personal wealth. I’ll be honest, Dan and I didn’t implement this right away. Our strategy was different. We saved enough dollars pre-launch to pay our personal expenses without tapping into the business. Now that we’ve fully implemented this system, we are consistently paying ourselves every month. It’s glorious. Each month, we take a certain percentage of revenue and transfer it to the Owners Pay account.
As your business revenue grows, your compensation should reflect that. Because this system uses percentages, you’ll naturally see your wages rise as your business revenue increases too.
The book I suggested to you is called, Profit First. Although I describe the Profit account last, as the book suggests, it should be the first place you distribute dollars to. This ensures your business is profitable. What do you do with the profit? You pay yourself. Nah, let’s rephrase that. You celebrate yourself. This account is established for quarterly distributions to owners. This is the profit you receive for being a rock-star business owner.
‘But, aren’t I already paying myself?’ Yes! You are. That wage should represent you as an employee of your business. The Profit account distribution is representative of you as the owner of your business. And for that my friends, we celebrate!
Depending on where you are at with your business and the revenue you bring in, your percentages will be unique to you. Lucky for us, Mike Michalowicz provides a basic outline for you to reference:
These are benchmarks to reach for. For newer businesses, the percentage for Expenses may be much higher while Owners Pay is lower. The goal is to get somewhat close to it. You’ll also note the order here. In Profit First, you pay yourself a profit first. Then make sure you are paid. Pay your taxes. Whatever is left over can be allocated for expenses. I love this mindset. It forces us, business owners, to make sure we spend within our means. Otherwise, your expenses would drive the rest of the categories!
For this to work, you’ll need to create a repetitive process. The book suggests two times a month. We do it once a month. Again, pick what’s best for you. At Fyooz Financial Planning, we log into our business bank account at the end of the month and process the following transfers:
Quarterly, we take a distribution from the Profit account. We pay ourselves on the first of each month from the Owners Pay account. Our taxes are distributed from the already funded Tax account. All expenses are directly debited from our Expense account. I’m telling you, this system is life-changing.
First things first, go read Profit First by Mike Michalowicz. That’s step one to making serious changes to your business financing. Step two is to incorporate accountability. Let your accountant know! Or, tell us! We’d love to hear how your journey is working with you. We love talking with other entrepreneurs about how they’ve incorporated this into their business.
Send us an email at firstname.lastname@example.org to share your purposeful business banking story or ask for help on how to get started today.
Disclaimer: This article is for informational purposes only and is not a recommendation of Fyooz Financial Planning, Natalie Slagle CFP®, or Daniel Slagle CFP®. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment or financial planning strategy. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.