Small business success depends on many factors – a solid business idea, a robust market for your product or service and effectively managing finances for your small business. Do the money management strategies that work for your personal finances work equally well for your business? Knowing how to manage finances in a small business can be very similar to running your own household finances—but also very different. Here’s a closer look at four common financial issues every individual and business faces and how to handle them.
Personal finances: You probably have a budget that allows for recurring monthly expenses such as your mortgage, car payments, groceries and more. Whether detailed or vague, a budget helps you ensure you’ve got adequate cash to cover your necessities each month. Having an emergency savings fund that can cover three to six months’ worth of your essential living expenses provides a cushion in case of a layoff or economic downturn. When an unanticipated expense arises, you can tap your emergency fund or cut back on discretionary spending, such as entertainment, to cover it. Without these safeguards, you might have to rely on more expensive options, such as credit cards or personal loans.
Business finances: Plan your small business finances by making a budget that accounts for both fixed and variable expenses, and build in a cushion for unexpected costs. A good rule of thumb is to put 10% of your monthly revenues in a savings account or interest-earning checking account. Build up a business emergency fund that can cover three to six months of operating expenses, and you’ll be ready for any eventuality.
Having additional business backup plans can prevent tapping personal savings or turning to high-interest business credit cards in an emergency. For instance, opening a business line of credit while your business is financially flush provides peace of mind that you can get through seasonal slumps or tough times. You won’t pay any interest on the credit line unless you tap into it.
Personal finances: Many of today’s personal finance gurus urge avoiding debt at all costs and paying down any debt you have as fast as possible. One popular school of thought advises living a bare-bones lifestyle, saving most of your income, and retiring in your forties or even earlier. While a penny-pinching, all-cash lifestyle may work for some individuals, it’s not realistic for all. Most people need to finance major purchases such as homes or vehicles.
Business finances: Striking a balance between cash and debt can work for your business as well as your personal finances. Lack of cash is a common reason small businesses fail, so attention to your budget is critical. To ensure you have enough cash on hand, stay on top of invoicing and accounts receivables, and follow up immediately on late payments. Consider switching to net 30 terms for your customers, while negotiating longer payment terms with your suppliers. Maintain a 12-month cash flow statement and compare your projections to your actual numbers once a week.
Business loans can be a valuable tool for growing your business by providing the capital you need to jump on opportunities. You can use a working capital or equipment loan to finance the machinery, inventory or employees you need to expand. Using borrowed money minimizes your risk and enables you to strike while the iron is hot. The key to successfully using business debt is careful budgeting, accurate forecasting and maintaining a positive cash flow.
Personal finances: Tax preparation software has simplified the process of filing income taxes, making it easy for millions of Americans to do their own income taxes. The IRS even offers free guided tax preparation for those who qualify. If your personal finances are relatively straightforward, preparing your own income taxes can save money compared to using a professional. You may want to opt for a tax preparer, though, if your finances are complicated or you’ve recently gone through a major life transition, such as inheriting money or getting divorced.
Business finances: You can prepare your business taxes yourself—but should you? Small business owners face taxes individual do not, such as self-employment taxes, payroll taxes, and quarterly estimated tax payments. Your business structure also affects your tax liability, adding to the complexity of tax preparation. Unless you enjoy keeping abreast of business tax law as a hobby, doing your own taxes most likely isn’t the best use of your time.
Whether you rely on an accountant all year or hire a tax preparer at tax time, these professionals can help you minimize taxes, maximize deductions and keep more of your hard-earned profits. An accountant with expertise in small business can also help show you how to manage a small business’s finances more effectively.
Personal finances: It may be tempting to run your small business using your personal checking and savings accounts, especially if you’re a sole proprietor or freelancer. After all, if no one else is involved in your business, won’t combining your business and personal funds simplify financial matters?
Business finances: Even for a one-person business, opening a business bank account should be one of the first steps to startup. Separating your business and personal accounts separate simplifies record-keeping, budgeting, and tax preparation for yourself and your business. It also demonstrates that your business is a legitimate operation, not just a hobby, and can help protect your personal funds from liability if your business is sued.
Beyond these basics, opening a business bank account is the first step in establishing a lasting banking relationship. A financial institution that offers advice from business bankers can help guide your business’s growth. When the time comes to seek a business line of credit, business loan, or SBA loan; a banker familiar with your business’s finances should be the first person you turn to.
Knowing how to manage a small business’s finances as well as you do your personal finances helps to lay the foundation for business success. As your business grows, you’ll gain more experience in when to manage your business finances the same way you handle your personal finances—and when not to.
This article originally appeared on Score.