Saving is a crucial part of business (and life). The future is unpredictable, so it’s important to have money set aside to cover regular expenses, emergencies, equipment repairs/replacement, unexpected slow months, etc.
Part 1 – Taxes
The biggest mistake I see in new business owners/independent contractors is failing to save for taxes throughout the year.
Now, this isn’t even technically saving money for your business. This is saving money that isn’t actually yours to begin with. When you’re an employee, taxes are taken out of your salary before you even get your paycheck. But when you’re self-employed, that responsibility is yours.
If you are a sole proprietor or single-member LLC, you are subject to self-employment tax (SE Tax) on 92.35% of your net earnings. For 2018, this rate was 15.3%, which is IN ADDITION to any federal income tax you owe. The general rule of thumb is to put aside 25-30% of your income to account for taxes.That means for every $1000 you make, you should save $250-$300 just to cover the taxes you will owe! Sounds like a lot, right? That’s why so many people get into trouble. They spend that money and aren’t prepared when it’s time to pay. Please don’t fall into this trap!
Note: If you are, or file as, a corporation, I still recommend following the 30% rule. You have different taxes to pay, and it’s always good to make sure you’re covered.
This is yet another reason you should have a CPA AND track your business expenses.
Your CPA will help you figure out your estimated quarterly taxes (which you’ll need to file in most cases to avoid penalties). And because the SE tax is on NET earnings, which is your income after valid business deductions have been taken out, reporting proper business expenses helps reduce what you owe!
Bonus tip: Half of the SE tax qualifies as a business deduction.
Part 2 – Savings
In addition to putting money aside for taxes, you should save for all of those unforeseen circumstances. What if you have a slow month? What if your laptop dies and you need to replace it? What if the client for that big project you did last month doesn’t pay you on time? So many things can happen that will require cash flow, so it’s your responsibility as a business owner to be prepared.
There’s no exact science to how much you should save, and every business has its own needs. The best thing my dad ever taught me as a kid was to save 10% of everything I make. I encourage you to do the same, at a minimum. I actually try to save 20%. That safety net gives me the comfort and freedom to do more of the things I want to do.
In addition, my recommendation and personal preference is to keep a minimum of 6 months’ income in your business savings account at all times. That money is there to cover emergencies, business improvements, and even fun (because sometimes you have to reward yourself for working so hard).
If you think you can’t afford to save, you need to address your budget.
The way I look at it, you can’t afford NOT to save. You’re going to owe those taxes no matter what you do. You’re going to encounter some unexpected expenses along the way. Your income is most likely going to fluctuate throughout the year. Hold yourself accountable TO YOURSELF. Save now so you don’t have to worry later. Planning ahead allows you to enjoy the perks of being your own boss!
How can I get into good saving habits?
Make regular payments to your savings account. Find what works for you. For some, I suggest transferring 40-50% (30% for taxes, 10-20% for savings) of each deposit into savings. So every time you a check is received, a portion is immediately put away. For others, it’s easier to do it once per month based on total income.
Set up a system to make sure you do it. Set up an automatic transfer from checking to savings once a month. Or put a weekly/monthly reminder in your phone to alert you to make transfer.
Stick with a percentage of income rather than a flat amount. This helps account for the fluctuation and/or seasonal behavior in business. Saving more during the busy months helps create a cushion for the slower ones.
If your savings account falls below your minimum comfort level, or you’re having trouble saving at least 40%, make adjustments to your budget until you get back on track. What are your unnecessary expenses? Are you taking your clients to lunch when you could actually be more productive meeting for coffee (which is much cheaper)? Are you paying for all the premium music subscription services when maybe you only need one? Could you be putting more time/effort into increasing your income? Saving is the one area of your budget you should never compromise!
Work hard. Save what you can. Earn your freedom. Isn’t that what entrepreneurship is all about?
Tomorrow I’ll share the last part of this Business Basics series, with everyone’s favorite – bookkeeping. I know, for most of you, it’s the worst part of owning a business. But I’ll tell you why it’s so important and doesn’t have to be so scary!