If you work for someone else, personal financial planning is a lot easier. A paycheck flies out of the black box every two weeks, you take that money, pay your bills & taxes, pay your debts, and invest what’s left.
Sure, there is the risk of the black box disappearing, but fortunately, that doesn’t happen a lot and there are backups such as unemployment insurance that can tide you over to the next paycheck-spewing black box. (I do make employment sound glamorous, don’t I?)
If you own a small business, particularly a new small business, financial planning becomes a lot more difficult. That black box now goes both ways. Sometimes it spews out a paycheck, but sometimes, it sucks money from you to keep going. Like a new puppy, sometimes it takes a lot more than it gives, making you rethink the whole arrangement.
So, I’ve laid out some tips to help you with your personal financial planning. These tips won’t make it easy, but I hope they will educate you on some things business owners need to do differently. And at the very end, I’ve included a list of resources to help you with your personal finance education.
Keep Your Personal & Business Finances Separate
With the proliferation of pass-through entities such as LLCs and S-Corporations, the line between your business and personal taxes gets very blurry. However, even if the business is a pass-through entity, keep your personal finances and business finances completely separate and document every exchange between the two. That means two bank accounts, two credit cards, and loans that are designated business or personal.
There are two reasons for this. First, the IRS only allows the deduction of business expenses. If they are all buried in one account or credit card, how do you track which is which? Second, if you are having personal financial difficulties, is it because of the business or because of your personal lifestyle?
Set Hard Limits on What You Will Feed Your Business
Businesses take money to start and run. Determine from the beginning how much money you will put into the business willingly and set a second limit— the absolute drop dead number you will not go past no matter what. And have this discussion with your spouse or significant other (if you share finances).
Businesses have setbacks. They often grow slower than you thought they would. Expenses come up that you didn’t expect. And the business preys on your emotions and past effort, begging you to put in more money than you are financially able. Sinking ships are hard to jump off of, but if you have already determined how much water you are willing to take on, you can perhaps be a bit more rational about the decision.
Don’t forget to document these exchanges of funds. Set up a “Loan from Shareholder” account on your business books. Track it. The business owes you the money and you want to get paid back. And the IRS differentiates between loan payments and shareholder distributions.
Expect a Lot From Your Business
So your business has survived the early, scary years. You no longer have to put in money to meet payroll. You are paying your bills timely. Cash flow is okay. Oh, and you pay yourself $1,000 a month. Time to take a hard look at this business that took all your money and effort early on and tell it to justify its existence.
At this point, you are not making a living wage and the business needs to become profitable enough to give you one. Maybe it is on its way to becoming wildly profitable and you aren’t ready to give it an ultimatum yet. So, mark your calendar. If you feel the same way in a year, something has to change. You might have to break up. And it’s not you, it’s the business. (By the way, that’s not a failure. That’s just good, rational decision-making.)
Protect Your Personal Assets
There is a common misunderstanding that the entity, the LLC or Corporation, provides you personal protection against your assets. It does provide you some limited liability, but not on debt. Why? Because no bank in the world is going to loan money to your business without a personal guarantee. Only the really big guys (think Chevron) get business loans with no personal guarantee.
The guarantee is signed when you close on the loan and it says if the business can’t pay, you will. Credit cards, even “business” cards are usually personally guaranteed. Some vendors will even require a personal guarantee to extend credit to the business. Once the guarantee is signed, your personal assets are exposed. And, no, there isn’t anything you can do about it if you want to borrow money.
When Things Go Really Badly, Bankruptcy Happens
Let’s say the business has a tremendous setback and you have outstanding debts — the product you sell becomes illegal, your manufacturer goes out of business, or the economy takes a dive. You could be faced with creditors demanding money that you can’t pay, and that’s when bankruptcy becomes a viable option.
Bankruptcy isn’t pretty, but it does allow you to gain control of the process. Once bankruptcy is declared, creditors cannot take business and personal assets to satisfy their debts. (Such as sweeping all the cash out of your bank account, for example.)
And, recognize that the bankruptcy will flow to you personally, just like the debts did. In fact, if your business is small and the debts are primarily personally guaranteed, the bankruptcy courts will skip over a business bankruptcy — which just adds costs to the process — and jump directly to a personal one. The states set their own bankruptcy laws, but most states allow you to keep your home (up to certain limits), a car, some personal items, and your retirement plans.
Keep Exempt Items Out of Your Business
So, my message to you is this. Don’t use items exempted from bankruptcy for your business. That means use 401(k) funds only as a last resort; use your savings first.
Don’t get a second mortgage on your house to fund the business. The house is a protected asset, but if the mortgage is in default, it isn’t. And if you think a bankruptcy isn’t enough, imagine losing your place to live as well.
Keep Your Personal Finances in Good Shape
Having a small business is all the more reason to ensure your personal finances are in good order.
First, your personal credit score is a large factor in obtaining financing for your business.
Second, if your personal finances are in good shape, the business will be less stressed trying to support itself and you. If you had to skip a paycheck for cash flow reasons, the better prepared you are personally, the less it will hurt. And that might mean the difference between having to borrow and not.
It’s hard to plan for your business or your personal finances if you don’t know how your business is doing. Let us help you clean up your accounting so you know where you are with your business.
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Resources for Personal Financial Planning
The web is filled with resources to help with financial planning. My only caveat is to know who provided the information. If they are selling an investment, of course that investment will be the one they recommend. Some of the information may be useful. Just recognize that they have a bias.
- Personal Finance for Dummies, by Eric Tyson. A great start for your personal finance journey. Not really for dummies, just a good beginning book explaining taxes, insurance, investments, and budgeting.
- The Dumb Things Smart People Do with Their Money: Thirteen Ways to Right Your Financial Wrongs, by Jill Schlesinger. A good “lessons learned” book on what to avoid in your personal finances. Argues that buying a home isn’t always the way to go and warns parents not to borrow heavily for their children’s education.
Regulations / Consumer Protections
- Consumer Financial Protection Bureau (www.consumerfinance.gov)
- Federal Trade Commission: Fair Debt Collection Practices Act (www.ftc.gov)
- Federal Trade Commission: Consumer Information (www.consumer.ftc.gov)
- Internal Revenue Service (www.irs.gov) – all tax regulations
- Credit Karma (www.creditkarma.com) – Free site for credit scores. Does not include Experian. Suggests credit cards and loans.
- My Fico (www.myfico.com) – The original FICO site. Includes all three credit scores (including Experian). Expensive to get your score and usually locks you into a subscription.
- Annual Credit Report (www.annualcreditreport.com) – The only site that is authorized to give you your annual free credit REPORT. Does not include your credit SCORE.
- The Big Three: Experian Credit (www.experian.com); Equifax Credit (www.equifax.com); Transunion Credit (www.transunion.com).
Financial Advice & Calculators
- Ally Bank (www.ally.com/do-it-right) – Various financial articles.
- Bureau of Labor Statistics ( www.bls.gov/ ) – Average wage and spending data.
- IRS Withholding Calculator (https://www.irs.gov/individuals/irs-withholding-calculator) – Calculate withholding and taxes.
- The College Investor (www.thecollegeinvestor.com) – Investing site for millennials. A lot of information on student loan debt.
- Quicken (www.quicken.com) – Still desktop-based, so it keeps your personal information out of the cloud. $35 – $100 software.
- GoodBudget (www.goodbudget.com) – Mobile App. $5.99/month for Plus. Can share with family.
- Mint (www.mint.com) – Mobile App. No charge. Makes credit card recommendations.
- Lending Tree (www.lendingtree.com) – Portal showing various loan offers.
- Credit Karma (www.creditkarma.com) – Portal showing various loan offers. And, two appearances on the list!
- SoFi (www.sofi.com) – Online lender of mortgages and term loans; quick turn-around; good rates.