When you are self-employed or doing contract work as a freelancer, the flow of income is rarely steady and often in lump sums, followed by periods of drought. Without control, it can be a feast-to-famine experience as you indulge on receipt of a lump sum and then overload credit facilities later as you wait for the next payment. We all know the tradie with the amazing ute who has to borrow $2 from his mates just so he can buy a pie!
So how do you manage the cash flow and minimise your tax while building your business and your wealth?
1. Know your financial position
Yes, I know this might seem like common sense, but many small business people do not have a true grasp of their net position during the year. You just have a good set of books and accounts that show you your assets and liabilities, especially as you approach May and June each year.
This puts you in the driving seat, and with some guidance from your accountant you can look at using salaries or dividends, superannuation contributions, bringing forward or delaying income, purchasing or delaying equipment or stock to maximise your after-tax position.
2. Pay yourself first
Get in the habit early on of taking a basic wage for yourself weekly or fortnightly. It does not have to be much to start with, but it should be enough to cover your very basic living costs. Many people live off their savings while starting a business; I would much prefer they lend those funds to the business and set themselves up with a basic wage.
This sets a good habit in place, especially if you have a spouse, partner or family, as they rely on you. They may support you in your endeavours, but a steady cash flow will help relieve their concerns. It also means you set a key business indicator (KPI) within your business to at least fund that payment, and this may often be your first real milestone.
3. Don’t hold valuable assets in your own name
As a small business owner or contractor, you carry a much higher litigation risk than people in paid employment. Don’t underestimate how much risk you carry.
Fact: Did you know that New South Wales is the third highest jurisdiction in the world for lawsuits per person, behind California and Texas in the USA? And Victoria is not far behind?
So structure the ownership of your assets with this in mind. You should be the ‘straw man’ and your partner or spouse the ‘person of substance’.
The man of straw takes all the risk. He or she signs their name to everything. The man of straw serves as the company director and trust appointer, and he signs his name to all the risky deals.
The person of substance does not place himself at risk. He signs his name to nothing for the business, yet he controls all the assets.
- The man of straw is the one who signs everything and controls nothing
- The person of substance does not put himself at risk, yet he or she controls all the assets
4. Never lock money away that you may need in the short term
Many people try to pay down their mortgage as quickly as possible, as it is what we term ‘bad debt’ or non-deductible debt. We recommend this strategy but with a twist. Every spare dollar should be placed in an offset account against your home loan or business loan instead of actually making additional capital repayments. This has the same effect as making capital repayments and reducing your interest bill, but it allows you quick access to a source of short-term funding rather than having to redraw or use costly overdraft facilities.
5. Build some wealth separate to your business
Yes, that old adage of not putting all your eggs in one basket still rings through today, especially as we see economies, markets and trends changing so quickly.
While you may love what you do and believe that it will make your wealthy, it is always good to have a Plan B. Putting funds away regularly into superannuation is building wealth in a structure that is well protected in the event of bankruptcy. Maybe do this with a view to owning your business premises in your own Self-Managed Super Fund (SMSF) eventually — make it part of your long-term business plan.
If you are investing in property on your own, then ensure that you maximise debt on that property so in the event of litigation you have little of your equity available to creditors.
A lot of what’s involved in managing your money for a small business owner or freelancer is about making a sporadic cash flow appear more stable; ensuring that you are not overexposed to your business to the detriment of your family wealth; and finally that you are protecting that wealth from business risks.