Self-employed must keep 12 months’ expenses
Irrespective of the profession you are in, it is absolutely essential to keep your cash flows in check. In order to successfully do this, you need to have a good understanding of your inflows and outflows. This is particularly important if you don’t have a fixed income or irregular income, as seen in the case of selfemployed individuals.
Self-employed people have irregular cash inflow depending on the business they do in a particular month. However, unlike their inflows, their outflows (payment of loans such as a car, house, etc, insurance premium) are fixed. Hence, it is crucial for self-employed individuals to have a solid base for contingencies. As a contingency, it is necessary to maintain at least 12 months of expenses. These savings can be in different forms; saving accounts, fixed deposits, liquid assets, and floating rate funds. This contingency fund can be reduced to around 4 months, depending on the stability of the business.
In the course of a business, one has good and bad months, with good months being the ones that generate more revenue. By keeping track of the business and revenue cycle, one can fall back on the revenue generated during the good months and save them as fixed deposits or floating rate funds for any emergency. It can also be used for any immediate requirements such as buying new equipment or a security deposit for new office space if required. Additionally, entrepreneurs should try and pay themselves a fixed salary every month and keep their business and personal account separate. Maintaining separate accounts will provide insight into current business expenses, profitability and give a clear picture of what’s happening with the business.
Managing debts is another key area of concern. With unexpected expenses cropping up, managing debts has become a crucial part of managing cash flows. One can use the debts to create assets to boost revenues and increase productivity rather than on things that will not add value. For example, for a doctor, it would be more important to have the best equipment and instruments in place rather than spending lakhs on interior decoration. Additionally, debts can be used wisely by opting for low-interest loans and overdrafts on Fixed Deposits, Mutual Funds, Stocks or Loan against property. Also, when using credit cards, it is advisable to pay the full due amount or at least pay more than the minimum required amount.
After all of the above is taken care of and before setting up the contingency fund, transfer risks to an insurance company i.e. buy medical, disability, life, asset (car, home, office, and equipment) and professional liability insurances. Without this key leg, one might end up exposing themselves, their venture and their family to big risks. Once all these are bases covered, it is advisable to create a financial plan based on the family’s need, retirement needs, and financial goals. Lastly, seeking a professional help can go a long way.
The writer is the founder of Happyness Factory