Know when to hold them. Know when to fold.
For most of us, thinking about setting up our finances puts a knot in the pit of our stomach. So in what follows, I want to provide a simple way to start.
Here, you’ll find some common sense solutions if you’re a creative, just entering the world of business -- as a freelancer or entrepreneur who knows little about budgets and numbers.
When you start, you don’t need to be fancy. It’s all pretty straightforward if you keep two questions in mind. First, what will you need to survive over the first six months? Second, will you be prepared to pay your taxes when they fall due?
Let’s look at each of these questions.
Question #1: What do you need to survive the first six months?
In the beginning, you’ll quite likely be living on hope and air. You’ve yet to prove there’s an audience for your product or your services. If you’re starting your venture full-time, you’ve still got to feed and house yourself as well as cover the start-up costs of your business.
Step One:
Put together three budgets for the start-up period (three to six months) that assume only expenses and no revenue.
Your first budget covers your personal expenses -- housing, transportation, insurance, food, student debt, etc. An excellent way to determine these expenses is to look through your checkbook and credit card summaries.
Your second budget is the projected business budget. You’ll find that your plan of action -- what you’re going to do -- will serve as a good outline for your business budget. Look at your business plan to get an estimate of your costs. Are you going to need money for a website, material, internet service, promotion, etc.? (Don’t underestimate the cost of promotion and marketing. If you’re invisible, you’ll find it hard to build your momentum.) Be goal-oriented and specific. What do you want to show for your efforts at the end of the first six months?
Your third budget is a time budget. Time is money and should be considered an expense as well as a source of revenue. You need to know how much time you spend to produce a product or deliver a service. It will help you determine the price you’ll charge. Knowing how you spend your time will also help you think about when to eliminate an activity because it doesn’t promise a return or, for that matter, increase your time when you see that it has great potential.
If you’re working on several fronts -- teaching, painting, offering workshops, as a barista, etc. -- figure out what percentage of your time you spend on each and what percent of revenue each provides.
It may seem odd to put together a budget that includes expenses with no mention of revenue. Expenses are real. Revenue is imaginary...at least when you start. Knowing what your business will cost you will allow you to think concretely about the cost of doing business.
Odder still may be to ask you to include a time budget in your financial planning. Knowing how you use your time can help you clarify something more than your efficiency: it can help you focus on your goals, what you are doing, and the value of each activity.
Step Two:
Determine the total amount of money you’ll need to cover both your personal budget and your projected business budget?
Don’t be surprised if the amount you think you’ll need is far beyond your current resources. For that matter, you may find that you’re spending more time on a task than you’d imagined. This may be especially true if you’re doing something you like to do: indeed, time flies when you enjoy your work. The more specific you are with these budgets, the better prepared you’ll be for your next step.
Step Three:
Cut and then cut again. Try to cut your total projected expenses (budget one and two) by 15 to 20%. You’ll find that there are areas that you can cut. For example, it might make sense to cut back on your business goals over the short term or collaborate with someone or some organization so you can develop some of your ideas with less money. Or you might be able to cut your personal expenses -- entertainment, eating out, cable, etc.
Don’t kick yourself if you’re spending time on things that you enjoy doing, even when they don’t have a payback. Just know you are.
Don’t forget to add the following:
Salary. Since you’re starting a business, you need to begin to pay yourself -- even if at the beginning you can only give yourself an IOU. If you don’t build this in at the start, you’ll not understand whether the business can sustain you.
Emergency Fund. As soon as you’re able, you should set aside money to cover the unforeseen. You probably won’t be able to add much to start with, but you try to build a fund covering two months of expenses. Then, you’ll rest easier knowing that when the “worst” happens, which is not unlikely, you’ll be prepared.
If you can establish an emergency fund when you begin, all the better. It will give you the flexibility to experiment while reducing the anxiety you face at the start of a business.
Step Four:
Keep Score.
From the first day, keep a tally of all expenses (both personal and business), and make a monthly comparison between your projected and actual expenses. When you see a difference between projections and realities, modify your budget. The need for these adjustments is natural so expect them. Each revision will give you a tighter and more realistic picture of your budget and your time.
There are several ways to track your projected expenses: Excel spreadsheets, Quickbooks, or any of the dynamic spreadsheets available online. At the start-up phase, consider a free spreadsheet. Excel or Google Spreadsheets are free. As a general rule, take advantage of all free apps and services. Yes, there are better ones that you can pay for, but don’t use them until you need to. When you’re starting, money is critical to your survival.
Several applications can help you track your time, but a rough count will do when you first start.
Keep in Mind A Basic Principle:
Think big. Start small. If you start by overreaching, you’ll drown in expenses before you can test your idea, its practicability, its appeal, and your ability to carry it off. The way you handle your finances will provide you with a framework that encourages you to track what you’re doing. (To understand this strategy, take a look at Eric Ries’ The Lean Startup and this overview.)
You’ll find that the better you’re able to track your finances, the more control you’ll have over your business. In addition, a clear picture of your budget will help you find ways not only to save money but to do more with the money you have.
Question #2: Will you be prepared to pay your taxes when they are due?
When you’re first starting, it’s easy—far too easy—to forget the fact that you will need to file your taxes. After all, you’ve not yet made any money, and April 15 seems a long way off. But it will come. Your budget should take taxes into account.
Knowing your expenses will prepare you to take deductions on your income. Separating your personal finances and your business finances will protect you if you face an audit. Establishing a business entity like an LLC, a business bank account, and acquiring a business identity number (Fed Tax ID) will make clear that you’re in business. (For more discussion.)
To be prepared, each month include your projected taxes—15 to 20% of your income.
More reading with links to online apps
Complete Guide: Setting Up Your Business Finances for the First Time.
Key Outlines on How to Understand Financial Statements and Budgets for Startups