Pay Yourself First

The number one reason businesses fail is they run out of money.  Cash flow is king, and lack of flow will close a business faster than any other cause.

The reason most businesses run out of money is they spend for non-essentials first, and don’t plan for the long term.   The easy way is to divide the income into budgeted items as soon as it arrives.

There’s a book making the rounds called “Profit First” that says to make the first portion of income be a level of profit. He suggests the first 20%-40% is profit, the return for adding value. That’s good in concept, but it assumes you’re generating enough income to have a 40% profit rate.  But for those in the government services space, 12% -15% is the top profit range.  For a retail or grocery business, 3% is good.

Instead, pay taxes, expenses and salaries first, including yourself.

Wages

Value your work in a way that you can outsource the tasks later.  It means you might be paying yourself a composite rate.  Perhaps you’re doing the bookkeeping, a $10 an hour task.  And you’re doing the mailing, an $8 task.  The content creating and editing is more valuable, perhaps $40 an hour, or $100 per article. Overall management is $50 an hour.

What if you do it all?  What if you do all the work, 52 weeks a year?  If you do, keep track of the time spent on each kind of task, and pay yourself accordingly.

With that calculation you can figure an hourly wage.  Divide the total annual wages by 52 to get weekly wages.  Divide that number by 55 hours a week to get hourly wage (for now, don’t consider overtime – you’re exempt!).

In this example, wages would be $87,880 a year, averaging $1,690 a week.  Divide that by 55 hours to get a composite wage of $31.96 an hour.  Write yourself a letter offering you the job for that amount (or less, if you’re cheap), and sign it as the owner or manager of the company.  Then write a reply letter to the manager accepting the offer, signed by you personally, as if you were the employee.

When you decide to hire help, take their jobs out of your composite wage.  Suppose you outsource your bookkeeping and shipping, but keep secretarial functions (correspondence) at 5 hours a week. You’re doing less work (45 hours a week) and therefore making $100 less ($1,575), even though your hourly wage is higher ($36.40).  So get to work doing 5 more hours of production labor each week.  The composite wage goes to $36.92 and your weekly salary goes back up, to $1,775.

Taxes
They say nothing is certain except death and taxes. If you die, you don’t have a business, so let’s only talk taxes for now. The third fastest way to get shut down is to not pay taxes. (The first is to violate a law, and the second is cash flow.)

Consider your current tax rate, or 22%, whichever is higher. In round numbers, 25% comes off the top: if your revenue is $200,000 your federal taxes are $50,000. State taxes are 5%.

You will need to pay Social Security for employees (yourself). In the above example, you will withhold $6,900 from ages and then match that amount, sending $3400 to the government 4 times a year. Budget for it.

If you rent space, pay suppliers, or have a phone, you will have monthly costs.  These have to be paid or the services will be shut off, causing harm to your business.

Then Profit

Only after expenses are covered can you declare a profit.  In the above examples, you will spend $150,000 just for expenses.  You can’t declare profit until those are covered.  You’ve earned yourself a good salary, but the purpose of business is to work yourself out of a job and let others do what you don’t want to.  After the business is successful, you can stop all the work and relax on profit alone.

Be sure to set your rates high enough to produce profit.  If you follow the example above, and you write research reports at $10,000 apiece, you will need to write 15 to break even. Try to get a contract for 20 a year. $200,000 minus $150,000 means you will pay a bit more in taxes, and may have some other expenses, but can still count on $30,000 in profit, a healthy 15%.

 

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