Every year at this time I tell myself that I am going to follow my own instructions, but sure enough I find myself deviating the way most small businesses, especially sole proprietors, do when it comes to money management. I think the best way to reinforce the principles is to write them out and post them on a little white board I have adjacent to my desk, but this year I decided to write them out for you as well.
It’s easy to let down your guard as a small business owner and find that you have spent more than you realize, always telling yourself that business is getting better, only to be hit by a ‘whammy’ when clients stop calling. Wise proprietors make plans so that in the tough times they have reserves to help them go from lean to mean again. Of course, we try to fool ourselves sometimes saying ‘things aren’t so bad’, all the while continuing with bad habits.
But as I said, proper ‘money management’ is key to keeping your cool day-in, day-out, and being ready for no matter what may happen tomorrow. Let’s look at a few principles to stay on the straight and narrow.
Set-aside Reserves from Revenues
I had a very good lawyer friend of mine who taught me this, by virtue of his bad habits. He would go months, sometimes even a couple of years, without any income because all of his cases were in ‘the legal process’; then suddenly he would win or settle a case and have ‘hundreds of thousands of dollars’ in fee income. He would go into ‘high spending mode’, not only paying what he owed to others, but buying new cars, expensive clothes, and taking elaborate vacations. Within a month’s time, he was practically broke, and at the end of the year, of course he ‘owed the tax man’ big time.
The natural tendency may be to 'spend like there is no tomorrow’ (the way our federal government does), but the prudent thing to do is to set aside reserves from every single dollar of revenue you receive.There are two such reserves you should establish:
- Operating Reserve – you should establish over time an operating reserve equal to a minimum of 90-days (many experts will tell you 180 days), but any business owner worth his grain of salt can surely get out and hustle up some business in 90-days, even if it is not the most ideal business. I think a good rule of thumb is to ‘tithe’ to this fund, by committing 10% of every dollar of revenue to this reserve until it is fully funded.
- Tax Reserve – there is no getting around it, ‘the tax man commeth, and the tax man taketh away’. While most ‘tax planners’ will tell you to set-aside 30 to 35% of your revenue for tax obligations, this can vary significantly based upon the actual costs and expenses that are associated with your business. I strive for 25% with the understanding that the ‘operating reserve’ can also help meet the tax obligation if it ends up being more than I anticipate.
Make, monitor and update your budget at least monthly.
While QuickBooks has some ‘tools for this’, they are not ‘that great’. Prior to the start of the year you should configure your budget based upon your past couple of years, as well as (let’s face it) your gut instinct as to what is happening in your business, and with the clients you serve. You are in a fairly good position to know if your client’s are ‘doing well’ or ‘sinking’ in their own businesses. This should give you some degree of expectation, ‘good or bad’, as to the type and value of business you are likely to see from them in the coming year.
- As you are reviewing revenue look at the Income by Customer Summary Report for a couple of years. With columns set to ‘year’ this will allow you to compare each of the last two years against each other. This is helps in determining recurring business that isn’t associated with ‘annual engagements’, and also helps you identify and ‘rule out’ big ‘one-time’ engagements that should not be ‘built into’ your new year’s revenue estimates.
- Look at your 2 year revenues by ‘month’ as well. This helps you determine how regular your revenue tends to be from month-to-month, remembering of course that you must divide these figures in-half to get a clear picture. Obviously this will help you forecast when you may have to access ‘operating reserves’ to deal with lean periods, and when you should be ‘contributing’ to those reserves during ‘times of plenty’.
- After your budget is established you should look at it in light of your actual revenue every couple of weeks, not just at month end. Are your revenues following projections, or are you behind (or hopefully ahead)? While we haven’t discussed ‘the expense’ side of the equation yet, it is obvious you should take the same approach with costs and overhead. It’s crucial that you examine every circumstance that impacts your monthly budget so that you can make adjustments. If you begin to recognize that ‘something adverse’ is happening in terms of revenues, you should take steps to either adjust for the downturn or seek new sources of income. Your reserve is there to ‘cushion you’, not ‘substitute’ for long-term revenue loss.
We preach job-costing to contractors, and manufacturers, but it is just as important for professional service providers as well, especially small entrepreneurs and sole proprietors. You really need to know if you are making a profit for the work you are doing. If you find that you are spending far too much time to get the work done than you quoted a client as part of a flat-rate engagement, then that is an engagement that either needs to be ‘scuttled’ or ‘re-negotiated.’ All too often we tend to re-issue engagements at the same price from year-to-year for clients we have had for some time. This is because we think we know the client and their business and just how much time it takes to do their work, but if we are not monitoring that time and comparing it against operating expense as well as revenue then we are really just guessing if we are making money.
- Create an estimate for every ‘job’, both hourly billings and flat rate engagements. We all know that QuickBooks uses these estimates as the basis for comparing ‘estimated to actual’ in job cost reports. If you have thought out a job sufficiently to either extend a letter of engagement for a flat rate, or estimate your hours such that the client is willing to authorize an hourly engagement, then it should be simple enough to convert those figures to an estimate.
- Track time and expense on every job, not just billable hour jobs. If you are already in the habit of tracking time for billing purposes for some clients, just remember to follow the same approach with your fixed fee engagements.
- Use the QuickBooks Job-costing reports for each and every client/job. Then take time to review those time entries, and associated costs (including personnel and personal expense) for that time to determine if you are charging your client enough. Even if you are making a profit, is that profit in line with your revenue expectations and budgeted income?
As I started out in the section on setting aside revenues, it’s easy to ‘go nuts’ when you have a big chunk of revenue come in the door, especially if times have been lean for a while. This is why it is essential to implement an ‘expense’ system that aids you in controlling overhead. Here are three steps you can take:
- Reduce credit-card reliance. Despite the various charge cards that make you think they are your best source of short term loans, they are not. They are really the door to long-term debt. Many money guru’s will tell you to cut all your credit cards up and never use them again, but in reality it is hard for a business to operate without at least one viable credit card for things like travel (most hotels will not let you check in without a credit-card even if you pre-pay the room charges). Similarly you can’t rent a car without a credit-card as security, and many will not take a debit card either. Just remember to consider all credit-card charges as an accounts payable and pay the balance in full with each billing.
- Consider a bank expense account with a debit card for your routine day-to-day out-of-pocket expenses. Transfer a fixed amount of money into this account from your regular business account ever week, or twice a month. This helps to create spending discipline because when the account is depleted you simply must wait until the account is replenished again. If you have employees, this is an excellent way to control their spending for things like business meals and entertainment. It also keeps all those charges well documented and easily traceable within QuickBooks.
- Prioritize Overhead as a Part of your Budget. While I could have mentioned this above under budgets, I think it is important to view it more as a function of expense management because in the long run, overhead is the most obvious area that you can reduce spending in light of recurring revenue or a revenue decline. You shouldn’t wait until you take a review hit to begin deciding what operating expenses have priorities over others. Naturally payroll taxes and earned wages if you have personnel must take a priority, but even though it is difficult to do there does come a point when personnel layoffs might be necessary if revenues decline significantly. Staying in business is a priority, and that means things like rent, utilities, and basic costs are a priority. Unless you sit-down and rank all of your expenses in order of importance ahead of time, emotion generally rules the day if you are forced to do this when the storehouse is empty.
I by no means have all the answers, I learn something new about my business every year. Sometimes what I learn is good news, and sometimes what I learn is "gosh, just how stupid was I when I did that". What I do know is that if you stand around like an ostrich with your head in the sand about your small business revenues and expense, hoping that everything will be OK, or get better soon, when you do finally ‘pull your head out’ you may find that your business is burning down around you and the fire department is nowhere to be found.