In the United States, tax season is upon us, and everyone’s thinking about how to manage finances.
[Raise your hand if you feel like you just figured out 2013 taxes. Sigh.]
Tax season presents an opportunity to do something different for the next fiscal year and to expect different results.
One of the biggest challenges for small business owners is budgeting. Your employees get a steady paycheck, but you often don’t! And if your business involves client work, then you might be accustomed to billing $4350 in February and billing $9725 in March. You can get totally slammed with new projects in April and see a tumbleweed blow through your deserted workdays in May.
Let’s talk about how to manage finances. Unlike other blog posts that I publish on Bright Newt, this one has a specific audience: people with “variable” income.
You might be a mobile app developer, freelance designer, co-founder of a high-growth startup, or the principal of a creative services shop. You might be a photographer, writer, or business consultant. If your month-to-month earnings fluctuate, then this blog post is for you.
Check out the simple, step-by-step plan below for bringing a bit more stability to your personal finances. The goal is getting off the feast-or-famine roller coaster.
Want to know how to manage finances the smart way?
If you’re wondering how to manage finances the smart way, the secret is dead simple: you can avoid overspending during drier months by living off the money you made in prior months.
In order to do that, you need a business checking account, a personal checking account, and a “storage tank”—i.e., a special savings account, preferably with a different bank. This storage tank is similar to the “emergency fund” or “rainy day fund” you might have for your personal finances.
While planning for your storage tank, don’t start with an arbitrary number. Instead, divide last year’s take-home pay by 12. That monthly average is a good target for your monthly budget, and thus for your storage tank.
Give yourself six months to fill up your storage tank
Follow these steps…
1. Using last year’s monthly average, create a tentative budget for this year. Let’s say that number is $6000.
3. Divide your monthly number by six. For example, $6000 divided by six is $1000.
4. Add that additional $1000 to your budget of $6000, and you’ll see that in order to fill up your storage tank, your monthly sales target needs to be $7000, plus whatever your business costs to operate each month. (So to be clear: $7000 will be your monthly salary, not your business’s total monthly earnings. Your business might bring in ~$8500, but you pay out $7000 to yourself for salary, $1000 for taxes, and $500 for operating expenses.)
5. Scrounge up that extra $1000 per month and withdraw it from your business checking account into a free SmartyPig savings account. Sell smiles and rainbows. Book Clarity.fm calls. Sell stuff on eBay or Craigslist. Mow yards in your neighborhood. Do whatever you’ve got to do to earn that extra $1000 and send it to SmartyPig. I like SmartyPig because it is SEPARATE from my regular checking account. The money is less accessible, so I’m rarely tempted to spend it. In fact, I often forget about it altogether.
6. By Day 1 of July, or Month 7, you’ll have $6000 in that SmartyPig savings account. Move all that money from SmartyPig account into your personal checking account. You’ll use it to pay your bills in July. Any profits you make—i.e., accounts receivable minus operating expenses and taxes—in July stays in your business checking account. If that number exceeds $6000, then you can stick with your original $6000 salary. But if that number is less than $6000, then you can adjust your salary accordingly to not spend more on personal expenses than your business can afford to pay you.
That’s the beauty of this little system: you’re budgeting based on money you’ve already got in the bank, not money you hope to make.
Now, build your Opportunity Fund.
To recap, the process goes like this: You bill your clients. They pay you. Those deposits go into your business checking account. You work hard to pay yourself a $7000/month salary. You transfer $6000 to your personal checking account and $1000 to your SmartyPig savings account. Once your SmartyPig savings account balance passes $6000, you can move the money to your personal savings account and start living on last month’s earnings.
Don’t be surprised when your efforts to generate that $7000/month salary continues to pay off past month number 6. You might start generating $7500, $8000, $10,000 a month, especially if you have more to sell than your own time—for example, product sales, sub-contractors’ time, or residual income from SaaS subscriptions or ad and in-app purchase revenues from mobile apps.
You’ll be tempted to jack up your budget and immediately start spending the surplus. Resist the temptation!
Keep moving the money to SmartyPig, and start building your “Opportunity Fund.” After I started licensing my mobile app source codes, Bright Newt began generating a surplus.
Because I sat on the money, I later had the opportunity to invest capital in Closeup.fm and become a co-founder.
P.S. – If you’re looking for more ways to create a more profitable app business or creative services shop, check out Freakishly Profitable. It’s chock full of practical tips for making more money.