If you’re planning a new business venture, you can’t expect to have a profitable business from the start.
The earliest days in business are the hardest. In fact, one-quarter of companies fail within the first 12 months, and most don’t become profitable businesses for 18-24 months. And those early profits usually go back into the business instead of the owner’s pockets. What’s more, even once you make regular profits, success can be elusive—half of all businesses close within five years.
That’s not to say that you should forgo the dream of starting a new business. It just underscores the importance of preparing for lean times so you don’t have to worry if your business doesn’t make as much money as you thought it would at the onset.
I would advise any entrepreneur—but especially those starting a business for the first time—to create a personal budget. You might want to focus entirely on your business; that’s understandable. But your personal financial plan deserves some attention, too. You will ultimately have more time for your business (not to mention a lot less stress in your life) if you know your own financial situation is secure, even if your business isn’t profitable to start. With that in mind, put these smart budget practices in place before you face any lean times:
1. Have cash reserves for your business—and yourself.
If you left a high-paying job to start a business of your own, you deserve credit for your boldness and willingness to follow your dreams. But you also need to be prepared for your finances to change dramatically. Estimates suggest that most small business owners make an average of $40,000 a year in their first five years in business. The good news is that you can make a salary even if your business isn’t profitable. The bad news is that if you don’t have a profitable business to start, you might feel guilty or reckless drawing anything except the smallest salary you can live on. Either way, business owners don’t often make big bucks, and at least not at first.
In the same way that it’s important to have cash reserves for business expenses, put away some cash for personal expenses. So how much should you have in your cash reserves? I recommend 1.5 years of cash to cover essential expenses and any “what-ifs.” However, I also realize that’s a lot of money to save, especially for someone who was making a steady salary but now has a completely unpredictable income. No one wants to put money aside for later when times already feel lean enough now—which is why it’s so important to plan ahead before starting a business.
Budgeting tools such as BrightPlan or Mint can be especially helpful for exploring where your money is going and putting more toward savings instead. When my husband and I started reviewing our expenses, we discovered just how much we spent eating out (much more than we thought!). Budgeting effectively and saving as much as possible start by getting visibility into all of your spending.
2. Budget for investing back into the business.
As an entrepreneur, your business is your baby. You want to do as much as you possibly can to see it succeed and are probably filled with excitement. You finally have total control of your work life and can take advantage of new opportunities.
However, this excitement can lead a lot of entrepreneurs to pour as much of their own money back into the business as they possibly can, which often results in two things: They put their own finances in jeopardy, but they still need to raise more money to have a profitable business.
Instead of investing every extra penny, budget how much of your income you can put back in the business. Because this can be an emotional process, I suggest using a technique called reverse budgeting to make it easier. You figure out how much you will need to cover all your personal expenses, including bills, retirement savings and the like. Then, you automatically put this amount into your savings account so you don’t have to think about it. Whatever you have left you can invest back into the business knowing you’re not compromising your personal well-being.
3. Know how to cut your expenses.
Will my business make money? Can I turn a good idea into a sustainable enterprise? These are the kinds of questions that keep entrepreneurs up at night. Fear of failure comes with the territory—which means that preparation should too.
Even if you start building up your cash reserves and putting important savings on autopilot, you might find yourself strapped for cash sometimes. When that happens, there’s likely only one option: tighten the belt. That never comes easily, of course, but entrepreneurs have excellent motivation within their business. If being a success a decade from now means giving up some creature comforts in the meanwhile, the sacrifice feels more worth it.
Look for any extra expenses such as subscriptions you don’t use (or don’t need), extravagances that you can do without (like eating out instead of cooking at home), or housing costs you might be able to reduce (like a landline you don’t even know the number for). At the same time, be aware of what you can’t cut (things like debt payments, for instance). The whole point of financial planning for business owners is to make smart decisions in the short term to put yourself in a better position in the long term.
Cash flow issues are the biggest obstacles facing new businesses, but they’re just as common and problematic for entrepreneurs themselves. Prepare for inevitable lean times that lie ahead, especially when it comes to your personal finances. The right budget helps you take them in stride.
Disclosure: This material has been prepared for informational purposes only and should not be used as investment, tax, legal, or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal, and accounting advisors.
Photo by @dina2378/Twenty20