Fifi asks about how best to manage her money when her income from month to month fluctuates a lot with some months bringing in just enough for her to get by. She also wonders how best to manage her credit score and to boost her monthly income.
I give a broad answer covering:
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I’m Melissa. As a full-time entrepreneur myself, I often find a difficulty in deciding how much monthly income to re-invest into my business and not OVERDO IT.
This reminds me of why I often lose at the board game "Monopoly", ha! Because I'll spend every last dollar on buying up houses and hotels and when I fall on someone else's property, I don't have the money to pay them. And it's a downward spiral from there, haha.
I'm sure you know just as well as I do that our businesses are our babies and sometimes we think we aren't feeding them enough to grow as fast as they can. But at times, over-investing can cause immediate problems.
What should I do to find a balance between re-investing as a business owner and putting money aside?
The trick to answering this question is uncovering what your goals are for the business and what your goals are for your private life. This will both allow you to decide how much to take out of the business and also when to exit the business, if ever.
I ran my own business from 2012 to 2017 and I had to answer this question myself. In the first year of the business I earned very little but I had saved over GBP60,000 because I knew I wouldn't make money from the get go. This is the reality for most businesses but from your question it sounds like you are past this stage and have some cash coming in, well done! You've gone past the first hurdle.
So, what kind of business are you running?
I’ll define the three categories:
The Lifestyle Business
A lifestyle business to me is one where you want to earn enough to support all your needs and a good portion of your wants. You don't hire too many permanent staff - perhaps you have a couple of virtual assistants - for your social media and bookkeeping and use freelancers for everything else.
The 'grow and sell' business
With a ‘grow and sell business’ you’re a little more focused on the business than on yourself so you’re a little more willing to “suffer” for a period of time by cutting off all wants and just extracting enough for your needs because the business comes first.
You want to get a consistent level of year-on-year growth and you want to track several observable metrics that will make it easier to sell your business in a time frame which you set. Sales numbers are the best metric to track but even social media statistics can be something worth measuring: healthy email lists, social media accounts with real followers, that kind of thing.
The legacy business
A legacy business is one that has to satisfy your income requirements for a prolonged period of time with a view to passing the business on to your children or selling far in the future if your children are not interested in running a business.
Once you’ve decided the type of business you’re running, then you need to go through the following process:
1. Figure out how much cash your business needs every month? This is your, “monthly cost of operations”
Some people think running an online business is virtually cost free but you and I both know it isn't so.
Sit down and calculate the minimum amount of cash the business needs to have just to keep chugging along. This should include the cost of all your tools: email marketing software, social media software, graphics tools, website hosts, budget for freelancers and other staff costs, advertising!
Back in 2012 when I started my business you could get a decent level of exposure for free, Facebook posts on pages were actually shown to people that had liked the page and you could monetise that exposure. Nowadays you have to spend money to get even low levels of exposure.
You probably also need a budget for taking courses that will help you grow your business. The marketing techniques that work are constantly changing and you will need to keep on top of marketing intelligence to grow your business.
So, it really is worth sitting down to figure these costs out. Once you have the number, you’ll know the minimum level of money you need to leave in your business bank account every month. Divide annual costs by 12 so that you have a reliable monthly cost of operations figure.
2. Figure out how much you need to live. This is your “monthly cost of living”
If you are fortunate enough to have your living costs mostly met by your parents or your partner then this won't be a large number.
My husband supported us for a good portion of my self-employment but I paid myself enough to cover my lifestyle costs: beauty products, going to cafes with friends, clothes, that type of thing and when we had our son, I made sure that the business covered his nursery costs too because the only reason he was going to nursery was because I needed to work.
Ultimately, this meant I took out about £600/month to cover four half-days of nursery each week and £670/month for myself.
The amount I paid myself wasn’t random: my accountant set my wage level just low enough not to have to pay national insurance tax. You will have to consider the tax impacts for yourself. That threshold moves every year. You could pay yourself more through dividends but speak to an accountant to get the balance right because if you pay dividends too often the taxman could say it looks like a salary and should therefore be taxed at the higher earned income tax rates.
If you can live on less than the sort of figure I am suggesting, even better.
If you're not living in a supported situation and have to pay all your own bills then this number could be much larger.
So, having done steps 1 and 2 you will know the minimum amount you need to keep the business going and plus the minimum amount the business needs to make to keep you going too. Is your business producing at least this much? I hope so.
3. How much do you want to save?
The next step is one I regret not having given enough focus when I was self-employed. I didn't save much at all for the household in that entire time. In fact, the only person that built up any savings is our son who had about £12,000 by the time I ditched the business and went back to work.
In fairness, the business was not making enough for me to save but if I think back I could probably have managed to put away £300-500/month for the family if I really wanted to. I didn't suddenly start earning more when my son was born so the fact that we managed to find over £300/month to grow his savings shows the money was there.
To decide on the ideal amount of money to save every month, project how much money you want to have at the age when you want to retire then using an online retirement calculator to figure out how much you ought to be saving every month. I found a good UK pension calculator on PensionBee.com and a good US retirement calculator on vanguard.com.
If you are running a lifestyle or legacy business and the business is generating not only enough to support operations but enough to save and live. Fab!
So, how's this different for a 'grow and flip' business?
If you are building a 'grow and flip' business then I wouldn't worry too much about the savings elements. If you can sustain operations and yourself then you can continue running the business and ploughing all excess money back into it in the hope that you will sell the business for a good lump-sum in say, 5 to 7 years.
Because this is a higher risk strategy you need to decide when you will quit the business. You can't continue running a business that doesn't allow you to put money into savings and investments indefinitely. You need to decide for yourself the point at which you will decide it isn't work.
What you take out of the business depends on:
1. What the business needs to keep going.
2. What you need to live.
3. What you need and want to save.
To attach some numbers to this discussion:
If your business is generating at least £1,500 every month (for example purposes) and it needs £800 to just keep moving then there's £700 left for you to either take for yourself or re-invest in the business.
If £700/month isn't enough to meet your living costs then you need to figure out how long your savings can support you while you give the business a chance to grow.
If your business is generating at least £5,000 or more every month and it needs £1,000 per month to sustain operations and you need another £2,000 for yourself then there's still £2,000 to play with. In this scenario, even if I was running a 'grow and flip' business I would save to hedge myself against the risk that my business isn't sellable.
A final thought. Ultimately, I left my business because it produced lower profits than I could earn in "regular job" and fortunately for me, I discovered that I actually love the routine of going to work and communing with my colleagues.
If over a two to three year period the business is generating you, say, £30,000/year and you know you could earn £50,000, £60,000 or even £100,000/year working, have a deep think through whether the long hours of building the business are worth it.
Many glamorise entrepreneurship but we both know the hours can be long and hard and the returns inconsistent from month to month and year to year.
For knowledge workers (Economists, lawyers, researchers etc. – desk-type jobs), the in-work flexibility is unreal nowadays and you could pretty much set up your life to be more flexible than an entrepreneurial life, with much more free time and real holidays where you actually leave your laptop at home!
Sorry if any of this last bit sound discouraging but I promised myself that when I blog about business I will always give people a real sense of what it's like. There are enough blogs out there pretending every 'trep is a millionaire when the reality is that the average self-employed person in both the UK and the US earns less than the average worker – shocking, right?
Hope this helps, Melissa.
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Heather on Wealth
I enjoy helping people think through their personal finances and blog about that here. Join my personal finance community at The Money Spot™.