Your business needs fuel (cash) to fly far and fast
Most small businesses fail because they run out of cash.
And when a plane runs out of fuel, it crashes. No matter how big and beautiful.
Small business cash flow made simple
Luckily, there's a financial blueprint we can follow to keep our planes from crashing.
A simple, yet effective, 6-step playbook that organizes your small business finances by leveraging five checking accounts.
Step 1: Open 5 Checking Accounts
Open five checking accounts and name them to reflect their appropriate functions:
- Operating Account
- Personal Account
- Business Profit Account
- Tax Account
- Investment Holding Account
You will use these accounts to create a fluid financial system that gives you control over your money.
Make sure all your accounts show up on your online banking portal so you can see the amounts in each account comparatively at a glance. This is key for clarity.
Step 2: Start with Your Operating Account
The Operating Account is your main account.
All the money for your business should flow in and out of this account.
All your business's revenue should flow into this account.
All your business's bills, except income taxes, should be paid out of this account.
Step 3: Establish a Personal Salary
Establishing a personal salary is critical to the health of your business because it provides a clear picture of what money belongs to you and what money belongs to the business that exists to make you more money.
Living off of a fixed salary for a long time allows you to establish the predictable rhythm you need to manage and grow your business.
Once you decide how much you need to make, set up an automated bi-monthly or monthly transfer from your Operating Account to your Personal Account.
Step 4: Establish a High-Water Mark for Your Operating Account
Establish an amount of money high enough to cover the largest hit your business might experience in a given month.
For example, if your payroll is $20,000 every two weeks, you might want to establish a high water mark of $40,000 for your Operating Account.
This amount keeps you safe yet doesn't allow a ton of excess money to sit around in your Operating Account.
Now let's say your Operating Account grows to $60,000 over time. This means you have $20,000 over your high-water mark sitting there doing nothing.
So what do you do?
You take the excess $20,000 and split it between your Business Profit Account and your Tax Account.
In other words, you transfer $10,000 to each account.
This keeps your Operating Account at its high-water mark of $40,000 and increases your Business Profit and Tax Accounts by $10,000 each.
Now when you log on to your bank's online platform, you can easily look at your Business Profit Account and know how much money is yours (on top of your salary).
You can also look at your Tax Account and feel great about the fact you have plenty of money to pay your quarterly business and salary taxes.
Step 5: Establish a High-Water Mark for Your Business Profit Account
Your Business Profit Account is where you store the money your business makes that does not need to go back into the company to operate.
This is your rainy-day fund.
The high-water mark is different for everybody and changes as your business grows. However, a good rule of thumb is six times your Operating Account's high-water mark.
In other words, if your Operating Account's high-water mark is $40,000, you should aim for a Business Profit Account high-water mark of $240,000.
That might sound like a lot of money sitting in an account not earning much, but your Business Profit Account is going to buy you one of the most valuable things a small business owner can have: peace of mind.
A strong rainy-day fund allows you to adapt to market changes and even pivot while your competition falls victim to high-time preference.
Step 6: Transfer Money into Your Investment Holding Account
What do you do when your Business Profit Account hits its high-water mark?
First off, congratulations. This is a great "problem" to have. It means your business is a profit-producing machine!
This money is all yours. You can do with it whatever you want.
However, before you go spending your hard-earned cash on shiny objects and depreciating toys, transfer money in excess of your high-water mark out of your Business Profit Account into your Investment Holding Account.
The very name of this account is going to pressure you to invest that money rather than buy more shiny objects and depreciating toys.
The money you put in your Investment Holding Account is the money that can seriously contribute to your personal wealth and freedom.
You can use that money to build your dream home, take month-long vacations, fund retirement accounts, purchase life insurance, gamble in the stock market, buy investment properties, or save in the most pristine asset the world has ever seen.
You can splurge on the Lambo or a pet tiger now, but if you wait to buy these things with the money you make off your investments, you can have the Lambo, the tiger, AND a consistent future revenue stream.
In other words, you'll be making money while you sleep.
Cheers to sleeping well!
As always, stay aware, stay educated, but most importantly stay cool.
Talk soon,
Old Man Winter
