Budgeting For Success
The Operating Budget is the money you keep in the business account to float you through rainy days.
There are several ways to prepare a budget. Some advisors recommend keeping enough to cover X months of expenses; some recommend keeping a couple of months of average gross revenue; others follow radical approaches like 'Profit First.
Rainy Day Fund
I like the Rainy Day Fund method. This is where you add up all of your fixed expenses, office or home office, insurance, subscriptions, average your variable expenses, such as marketing, contractor payments, etc., and build a payroll cushion.
Let's say your home office is 25% of your total home, and your mortgage is $2,000 per month. Your home office is a fixed expense of $500 per month to your business.
You use your cell phone and home internet for business about 75% of the time, and both are $100 per month, totaling $200. That's a $150 expense per month to the business.
Finally, all of your subscriptions are $500.
Your total Fixed Expenses are $1,150
You spend roughly $500 per month on marketing.
Your contractors are an average of $2,000 per month.
The Total Variable Expenses are $2,500.
The owner's compensation is $3,000 per month, and for your one employee, payroll is $2,000 per month. (We want to withhold enough to cover the owner's comp for 1 month and the employee's payroll for 3-6 months depending on the stability of the business)
Total Fixed + Variable Expenses = $3,650 x3 months = $10,950
Owners Compensation + (Payroll x3 months) = $9,000
A reasonable operating budget to keep in the business account may be about $20,000.
Anything above $20,000 each month, you can transfer to your personal account as a "Shareholder Distribution" to spend on investments, personal expenses, and whatever else you'd like; save 20% for the Feds and 5-10% for the State.
A Couple of Months of Revenue
My colleague Drew is our Tax Manager, and he is much more in tune with your Shareholder Basis. This is the amount you actually get taxed on, and if you'd like to know more about how it works, I linked his article in the last sentence.
Basically, each time you earn money in your business, your basis goes up. When you spend money in the business, the basis goes down. By retaining 2 months of average revenue, you never need to worry about going on a negative basis.
(Negative Basis=Capital Gains)
You don't have to pick one method or the other; they can work together!
As GAAP (Generally Accepted Accounting Principles) trained accountants, we tend to stick with the familiar: traditional bookkeeping and charts of accounts, double-entry accounting, etc., but there are systems that many people find helpful.
One such example is the book 'Profit First' by Mike Michalowicz. In this book, author Mike Michalowicz explains his challenges with maintaining a budget, keeping his business lean, and providing his methods for keeping profit up and expenses down.
His method involves 7 bank accounts! Revenue, Profit, Owners Comp, Tax, Expenses, and at another bank, Profit Hold and Tax Hold.
For some, it works really well. Just keep in mind that multiple accounts increase bookkeeping complexity.
As a Collective member, you may need an Advanced Bookkeeping Plan, which starts at $99 for up to 75 transactions and 3 bank accounts. To truly run Profit First, bookkeeping could be an extra $149-$299 per month.
There you go! Three ways to manage your business's budget that are tax-friendly. For all other helpful articles, please visit help.collective.com.