Today, I’m diving right in with a topic that may not be as glamorous as your latest product launch or as thrilling as a new marketing campaign, but it’s absolutely crucial – clean books and solid financial systems.
Now, before your eyes glaze over at the thought of spreadsheets and balance sheets, stay with me. This isn’t just about juggling numbers – it’s about laying the foundation for your business’s success, its market value, and simplifying and de-stressing your life (and that of your accountant!).
I’ve noticed some common mistakes that business owners make over and over again – errors that can severely deflate the value of your business, create unnecessary stress, and cloud the clarity of your financial landscape.
Here are some of the mistakes I’m seeing that aren’t doing your business’s value, your stress level, or your accountant any favors.
🔍 Mixed Books: The Tangled Web
Think about the last time you tried to untangle a pair of knotted headphones. That’s the exact feeling mixed books evoke. Blending multiple business interests within the same accounts creates a financial labyrinth that’s hard to navigate. This practice not only obscures the profitability of each business but also confuses potential buyers.
The solution? Keep separate accounts for separate businesses. Today its easy enough to spin up a separate LLC and bank account. Personally I’m a fan of Mercury for fast and easy online business banking.
💰 Ducking Profits to Dodge Taxes: The Double-Edged Sword
Nobody enjoys paying taxes, but burying profits to avoid taxes can significantly slash your business value. Remember, your business’s worth hinges primarily on its profitability. Downplaying this to save on taxes is a strategy that can boomerang back when it’s time to sell. If selling in the next few years is a possibility then you must stop this now.
Remember, it’s not just what you earn – it is all about what you keep!
Now repeat after me – “Its not profit until it hits my personal account”. I have a good friend with a fast growing business with dozens of employees. He believes it to be very profitable but he keeps “putting the profits back into the business”.
That’s 👏 not 👏 profit 👏.
Your business value will be judged based on the owner benefit. If you want to plow your excess earnings into growth that’s great but when a suitor comes knocking just know that they will judge your business value largely based on the profit you take.
🤷🏻 Unpredictable Profit-Taking
Running a business without a roadmap for determining when and how much profit to take is like trying to navigate a maze blindfolded. It’s surprising how even bigger companies can fall into this trap. A sound profit-taking system can guide your financial decisions, stave off stress, and prevent financial missteps.
If you have a small business that you never plan to sell then maybe its ok to take the advice of “take profit when you need it” but this is terrible advice if you have partners, offer profit sharing, need to qualify for personal credit, or have an eye on an exit one day.
Here’s a profit-taking system that worked for me and a number of fellow entrepreneurs:
- Pay yourself a reasonable and customary salary in the form of a W2. There are lots of resources for discovering reasonable and customary. If your spouse is involved in the business do the same for his or her role and max out both your pre-tax retirement savings.
- Determine your monthly burn rate. In businesses with uneven or heavy capital demands this can be challenging so zoom out and look at larger picture to get your average.
- Decide how many months burn you need to retain. In my case, the business was a recurring revenue model with mostly monthly billing for customers. We were comfortable holding just 45 days. Only you can decide how many months you’re comfortable with. More than 6 seems like too much for most businesses.
- Take quarterly profits and pay your taxes. Each quarter, use your P&L to determine and the calculation you made in step 3 above to determine what you’re leaving in the business and then take profits for all the earnings over and above that amount.
There are a number of benefits to this system:
- You will have established regular income should you need to borrow personally.
- You will maximize your pre-tax retirement savings.
- You will have a clear way to determine bonuses and profit sharing.
- You won’t find yourself behind in taxes at the end of the year.
- You won’t have as many sleepless nights
- You’ll be able to easily show the profit your business produces
As always, consult with you CPA or tax advisor on these matters.
So, there it is! While a financial ‘spring clean’ might not top your list of exciting tasks, it’s an indispensable step towards a more valuable, marketable, and manageable business.
Here’s the bottom line: procedures and systems aren’t just nice-to-haves; they are value creators. They make your business more attractive to potential buyers and streamline your operations, which in turn, enhances your life as a business owner.
Remember, it’s never too late to start tidying up your financial house. Here’s to your continued success and a brighter, more organized financial future!
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