There’s a ton of information on how to make money. But then what?
Where do you put it? How do you spend it? Or more importantly, how do you NOT spend it and make sure you always have enough to pay your bills?
Let’s talk about Cash Flow Management.
You Need a Separate Business Bank Account
Do NOT mix and mingle your business income and expenses with your personal finances.
Whatever money you make as your business – put that into a separate account. Whatever money you spend for your business – pay that out of this separate account. Pretty simple stuff that helps you avoid a lot of headaches and heartaches come tax time, and it will keep you out of potential legal trouble.
Establishing a separate business entity like an LLC creates a protective barrier between your business and personal assets. In the unfortunate event that someone sues your business, they could come after you for all your business is worth, but wouldn’t be able to touch your house, your personal savings, or your Pokemon card collection.
But if you throw all of your business income into same checking account you use to pay for groceries and streaming services, and you’re using the same credit card to buy socks and pay for business accounting services… then where is the line? The court probably isn’t going to try to do the math for you. They’ll just see that you aren’t bothering to keep your business and personal assets separate, so why should they?
And then it’s bye bye, Blastoise.
More importantly and practically, keeping your business finances separate gives you a lot more clarity into your business health. You can really get a good view into what your money is doing by following the next tip….
Open More Accounts
There are different cash management frameworks you can follow.
I’m a fan of Mike Michalowicz’s “Profit First” method – which I’ve touched on before.
Donald Miller teaches a very similar “Cash Flow Made Simple” method with a few differences that might be a better fit for some types of businesses.
But the main idea of both frameworks is this: Divvy up your business income into separate smaller accounts. Essentially, it’s the envelope system.
Profit First in a Nutshell
The Profit First method recommends you open five separate bank accounts:
- Income
- Profit
- Operating Expenses
- Taxes
- Owners Pay
Everything you earn initially goes into the Income account. Then on a regular (ex. biweekly) basis you transfer EVERYTHING from your Income account into the smaller buckets.
For example, every other week you would transfer 25% of your Income account to Taxes, 20% to Operating Expenses, 50% to Owners Pay, and 5% to Profit. You can customize these percentages to your specific situation. If you sell physical good you’ll probably need a larger Operating Expense bucket, and the more expenses you have, the less you’ll pay in taxes. So instead of 25% going to Tax and 20% going to OpEx, you might allocate 15% to Tax and 30% OpEx.
You can learn more about how you use each of these accounts by watching this video, but it’s pretty self explanatory: Use Operating Expenses to cover your expenses, use Taxes to pay your tax bill, Owner’s Pay is used to compensate yourself for the work you do for your business, and Profit is for funsies! Actually, half of it is for fun, and half of it can be transferred to a long term savings account where you can let it build up for a larger investment in your business or as a rainy day fund.
“Cash Flow Made Simple” Made Simple
In the Cash Flow Made Simple method which is outlined in Donald Miller’s newest book, How to Grow Your Small Business, you also open 5 bank accounts, but they look and work a little differently. These accounts are:
- Operating Account
- Taxes
- Business Profit
- Owner’s Personal Account
- and Investment Holding Account.
Everything flows into a main Operating Account, and you use this account to pay your business expenses, including payroll (and your own salary). You might think of it as the Income, OpEx, and Owner’s Pay accounts all rolled together.
Unlike the Profit First method where you regularly empty the Income account into the sub-accounts, your Operating Account continually has cash flowing in and out of it. But you set a “high water mark.” If your account accumulates more than, say $8,000 (a little more than enough to cover your business expenses and payroll for a month; and remember you also pay yourself out of this account and transfer a fixed salary to your personal account twice a month), all of the excess flows over into your other accounts: Half of it goes to Taxes, and half of it goes to Business Profit.
And then the Business Profit account gets broken down further from there.
Before you party hardy with your profit, let this Business Profit account accumulate a bit. Donald Miller recommends setting the high water mark on this account to about 6x that of the Operating Account. So if we were waiting for the Operating Account to hit $8K before moving money around, we’re going to let the Profit tub fill up to $48K. That way you have a nice, juicy cash reserve you can dip into.
In case business gets a little dry for a few months, you can still make payroll and fulfill your commitments without losing too much sweat or sleep. Before you blow your cash on a Countach, use your profit to buy you some peace of mind.
And THEN – after you hit the high water mark for your Profit account – you’re ready to siphon some of the excess into your personal account as a profit distribution (finally start saving for that Lambo), and put some into an investment holding account that you use to buy things that make you more money – stocks, real estate, other investments (Hello, Blastoise!).
Where Should You Open All of These Business Accounts?
Here’s the cool thing – whichever framework you choose to follow (shameless shout out to my favorite business banking solution) – Relay Financial has tools that make it stupid easy to set up your cash flow management system with sub-accounts and auto transfer rules. They even have a pre-made “Profit First” automation that will automatically divvy up your Income according to your preferred percentage allocations.
OR if you prefer Donald Miller’s method, you can use Relay’s “Maximum Balance” auto transfer rule to automatically sweep excess cash from your Operating Account into your Tax and Profit accounts.
And Relay just launched interest bearing savings accounts. So you can earn a little money on your idle cash. This would be especially great for your Profit and Tax accounts – anything that’s going to sit there and build up a bit before moving it anywhere. At the time of this recording Relay is offering 1% APY on balances up to $50k, 1.5% on balances between $50 and $250K, 2% on $250K and $1M, and 3% on $1M and above.
To be perfectly honest, those interest rates doesn’t exactly break the “Wow” barrier; especially when Marcus is offering 4.15% APY on their savings accounts, Wealthfront offers 4.55%, and Robinhood offers 4.65% on the brokerage cash accounts. There are definitely places you can keep your money that will give you a better yield. I’ve actually set up my own cash management system to keep a portion of my profit distribution in a Marcus account.
But considering that most traditional business banks like Chase and Bank of America offer a whopping 0.01% on their savings accounts, Relay’s 1-3% looks mighty fine. And you get to earn interest while keeping your business cash under one roof instead of sending it out into a bunch of separate banks where you begin to lose clarity into your business finances.
And clarity is the name of the game here. Nobody is going to get rich off of an extra 2 or 3% return on a tax savings account. What is a lot more valuable – and not just conceptually valuable – is clarity and confidence. I truly believe you will actually make a lot more money if you understand your money; where it is and what it’s doing.
Which Cash Management Method Should You Follow?
Which system is best for you? I know you hate to hear it, but… it depends. I really like them both, and I apply concepts from both Profit First and Cash Flow Made Simple in different ways across my different businesses.
I think Profit First is a great place to start. I like Mike Michalowicz’s philosophy of prioritizing profit so that you can actually enjoy and reward yourself for the work you put into your business, even if it’s early stages. I believe that is important for keeping you excited about your business and making sure it’s working for you.
Donald Miller’s approach is really smart, and really safe, but if you want to follow it to a T, you essentially need to wait until you have a 6 month emergency fund built up before you get access to any fun money.
But don’t misunderstand, both of these cash management frameworks are going to get you paid. They both treat Owner’s Pay or Owner’s Compensation separately from Profit.
Again, Profit First is a bit more accommodating for folks just starting out: sole proprietors, single member LLCs that do not have an S corp election; anyone who takes their pay as a simple draw (as opposed to putting themselves on payroll).
Whereas Cash Flow Made Simple seems like it assumes that you are set up to pay yourself a salary as a W2 employee (as you would in an S-Corp) or a guaranteed payment (if you are a partnership). This also explains why this method doesn’t take out money for taxes until after you’ve paid yourself, as opposed to the Profit First method which sets taxes aside as percentage of top line revenue (and then you can increase or decrease that percentage based on your expenses and how you handle your compensation).
Before you commit to one method over the other, test them both out on paper (or a spreadsheet) and get a feel for which one will work best for your particular business structure and situation.
Don’t Just Sit There
I want to wrap up by emphasizing the importance of getting some sort of cash management system in place. It can be Profit First, it can be Cash Flow Made Simple, it can be a hybrid of the two, it can be something completely different. Whatever you do, be intentional with your money. Don’t just make money and spend money without knowing how much is going to where. Own your money and put it to work. At the absolute very least – set up a separate tax account and start setting aside about 20-25% of your income into that account. And then build a more complex cash management system from there.
Breaking down your cash into smaller buckets is a simple way to get a handle on your money, which helps you learn to live and run your business within your means, and spend less time stressing about whether or not you have enough to cover your liabilities.
Links to the books I referenced are posted below. If you shop through those links I may get a small commission which is a great way to support this site, and you can also support the Self-Employment Sidekick by checking out Relay Financial and their suite of free cash management tools. When you sign up and fund an account through my link sidekick.show/relay, you’ll get a little bonus to that you can use to buy the books and learn even more about how to build a beautiful new cash flow system and grow your small business.
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