Business fitness
You wouldn’t run a marathon or lift weights without building your core fitness. The same principles apply when starting a small business.
Setting up your own business is a great way to create wealth – if your business is one of the few that survives the first five years.
For every successful business, there are several that consume wealth rather than create it. The interaction between personal finances and business finances is a critical area which can affect the outcome of a business venture.
The way in which you manage your personal finances can either support or undermine your business success.
Starting out in business is best done from a solid foundation. Personal financial resources provide the initial capital for a new business and the more capital available the better.
Insufficient capital is one of the leading causes of business failure. While money is important, getting yourself in the right shape to start a business means taking care of other aspects of financial fitness. Strengthen your financial position by learning how to stick to a budget, making sure you have a will and putting in place insurance cover that will give you, your family and your business the resources to keep going in the event of your death or illness.
Financial fitness has parallels to physical fitness. You wouldn’t dream of running a marathon or lifting heavy weights without building your core strength. Nor should you set out to build a business without being in strong financial shape.
If there is one thing that can seriously undermine the foundations of a business it is a high level of drawings taken out to provide a personal income for the owner.
Raiding the business coffers to pay off personal debt or provide a lavish lifestyle will deplete the cashflow, which is the lifeblood of a business.
For this reason, it is imperative that there is a clear separation between business finances and personal finances. When a new business is expanding and has a high need for cash, it is easy to get into the trap of mingling business and personal money and juggling money in a merry-go-round between bank accounts to try to meet both business and personal needs. The result is usually chaos which makes it difficult to keep either business or personal finances under control.
It is common for business income to fluctuate significantly from one month to the next, particularly when a business is new. This doesn’t mean to say that your personal income needs to fluctuate. In fact, the more variability in your business income, the more important it is to create certainty for personal income by taking out a fixed level of drawings each month.
In order to do this, you will need to have a cash buffer in your business account so you can pay yourself in months when business income is low. You will also need to resist the temptation to increase personal drawings when you’ve had a good month in the business.
Creating certainty around your personal income gives you a greater ability to plan and control personal spending. This helps keep personal debt to a minimum and improves your personal financial fitness.
As the business grows and profitability increases, you will have choices about what to do with surplus funds that accumulate in the business. You can reinvest profit back into the business to grow it further, you can pay off business debt, you can increase your personal drawings or you can invest in other assets such as property or other businesses.
One of the key principles of investment is diversification and many business owners make the mistake of not building wealth outside their main business. Successful entrepreneurs spread their wealth across multiple investments, and property is often used as a store of wealth with less risk attached to it than to a business. Over time, property creates equity which can be used as security for funds borrowed for business expansion.
Just as with any other investment asset, the real wealth is made when a business is sold. It can take years of careful planning and preparation to get a business ready for sale in a way that will maximise the value created. A business which can operate with minimal input from the owner, which has well-documented systems, a loyal client base, a competitive range of products or services and a great brand is likely to achieve a good sale price.
❚ Liz Koh is an authorised financial adviser and author of Your Money Personality: Unlock the Secret to a Rich and Happy Life, Awa Press. The advice given here is general and does not constitute specific advice to any person. A disclosure statement can be obtained free of charge by calling 0800 273 847.