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Personal Financial Planning For Small Businesses

Prachi Juneja
management study guide
Related Topic
:- Finance Financial skill

Personal Financial Planning For Small Businesses

 

There are several books that provide information about how finances should be managed at a personal level. However, almost all of those books are written from the point of view of people who have a salaried income. People who earn their incomes from self-employment or by creating a small business face problems which are quite different from salaried people. It is therefore important for them to keep in mind some additional principles along with the basics of financial planning while taking decisions.

In this article, we will discuss how small business owners and self-employed personnel should manage their personal finances.

Segregation of Personal and Business Finance

The most common mistake made by small business owners is that they do not segregate their personal finances from business finances. For example, it is common for a business owner to think about expanding their business by using funds that they may have earmarked for personal purposes. It is quite common for entrepreneurs to use their kids’ college fund or their retirement fund in order to expand their business. A lot of the time, small business owners are successful and they are able to temporarily divert their funds to their business and then make them available for personal use just at the right time. However, many times they are unable to retrieve the funds and as a result, their personal financial goals suffer.

The best way for business owners to segregate their personal finances from business finances is that they need to pay themselves a fixed salary for their time and effort. This salary should be invested in projects other than their business. This helps the small business owner from keeping all their eggs in the same basket i.e. their business.

Liquidity Planning

For salaried people, the liquidity risk is relatively low. Most people work for big companies that do not normally have liquidity problems. Hence, they are assured that they will receive their salary on time. It is important to note that both the quantum of money as well as the time when it will be received is fixed. It is for this reason that they can easily plan their finances.

However, in the case of small business owners, their cash flow keeps on changing on a month to month basis. Neither the quantum of money nor its timing is fixed. This is the reason why small businesses often find themselves temporarily out of cash. In many cases, the business owner infuses this cash himself and often they jeopardize their personal finances by doing so.

It is important to manage the liquidity needs of a small business in an organized manner. Hence, just like an emergency fund is created for the needs of an individual, an emergency fund needs to be created for the business as well. Three to six months of the expenses of the business need to be held in this fund. This fund should be used for short-term liquidity needs and then should be funded back when the money is received. If the emergency fund also gets depleted, the business owner should try to speed up their receivables process, or alternatively, they should also try to raise money via external sources. It is not recommended that the small business owner dip into their own savings every time or use their personal property as a lien in order to obtain a loan. The tendency to mix personal finance and small business finance might seem lucrative in the short run. However, it can have disastrous consequences in the long run.

Funding a Retirement Plan

The number one objective of most small business owners is to fund their business. Hence, if they have any additional cash left, they usually turn it over to their businesses and try to expand it. As a result, very few business owners have any kind of retirement plan. However, it is quite possible that the small business may not be financially viable in a few years. In such situations, it is important that the owner has a backup plan. There is no legal mandate for small business owners to invest in retirement accounts and neither is anyone going to match their contribution. However, it is still imperative for business owners to fund these plans. They can also claim the tax benefits for the same.

Not Having Enough Insurance

Lastly, life and health insurance are provided to many employees by their employers. This is not the case for self-employed personnel. In their case, they are required to buy these insurances from the market. Many small business owners do not buy such insurances at an early stage. At a later stage, the private companies are not willing to give them insurance since they may have pre-existing conditions. There are several small business owners who have suffered since they have not budgeted for and paid insurance premiums for themselves. This includes insurance for life, health, and home and also for business-related insurances which protect them from liability and torts related claims.

The bottom line is that the personal financial planning process is quite different for a small business owner. They need to ensure that they do not get their finances mixed up with the business finances. Experience has shown that this is easier said than done and in the long run, the finances often get mixed up.

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