The 5 things you need to know before starting a business

At Bounce, whilst we provide advice on personal finances, we work with a lot of business owners. Why is this? Well when it comes to business owners you can’t take any chances with your finances. Whilst employees have the comfort of a regular pay check coming in if they get into trouble, a business owner’s income can be variable meaning not planning your finances can quickly result in disaster.

Sadly, I’ve seen too many good, profitable businesses go under because the owner did not set their personal finances up to weather the variability of business. In this circumstance, they usually need to close the business and quickly get a job to support the family. So how can you avoid this? Here are my top 5 things you need to know before starting a business.

No 1: You need to save before starting a business

I see a lot of entrepreneur influencers which tell people to ‘just take the leap’ and ‘figure it out as you go’. This may work if you have invented the next Facebook, but for most people, your business is going to take some time to get off the ground. I’ve read that 60% of small businesses in Australia fail within the first 3 years. Having some money in the bank will allow you to have some runway whilst you figure out how to make your business profitable.

In travelling, it is commonly said to half your luggage and double your savings. In business, I always say half your expectations of sales and double your expectation of costs.

No 2: Cashflow is king

This fits in with rule no 1 about saving money. A business requires a lot of cashflow. You may need to get a premises, invest in equipment and start hiring staff, all before making a single dollar. As you grow, you will constantly need to be upgrading as if you’re a bigger business before you have the sales of a bigger business. For a great example of this, I encourage you to read ‘Shoe Dog’ by Phil Knight, the owner of Nike. This book is the best example I have ever read of the perils of cashflow.

No 3: Set your business up as a business from day one

Before starting a business, set up a separate bank account. Even if you plan to run the business as a sole trader, combining your business finances with your personal finances will very quickly become a nightmare.

Depending on whether you are setting up a full-time gig or a ‘side hustle’, you will need to consider speaking to an accountant, setting up business structures and registering for GST.

No 4: Revenue does not equal your salary

It can be very exciting when you first start your business and receive your first sale. Suddenly you have money in the bank and you can do things with it! Well stop and take a breath because that money isn’t all yours. If you are registered for GST, a portion of that will need to go to your friendly neighbourhood tax man. In addition, if you do take the income, you will likely have to pay income tax on it which could be up to 47%. From there, you need to assign money to the costs of running the business and put money aside for future growth. You will quickly find out that after all these expenses, your salary isn’t as great as you think it is going to be.

This is why I highly recommend keeping a separate bank account, to make it clear what is your money and what is ‘business money’. Some business owners like to set up separate bank accounts where they direct a portion for tax, a portion for costs, retain a portion for cashflow and pay themselves from the rest. Each business is different, but everyone needs to pay tax and costs.

No 5: Don’t under-price yourself

A common scenario I see regularly goes like this. Someone decides to start a business because they want to keep more profits for themselves. They work in the industry and decide they could do it cheaper, so they have cheaper prices then their competitors. They argue that as they scale, their costs will go down, so they’ll make even more money. But that’s now how this works.

This is dependent on the type of business you start but this comes up a lot with service businesses. They start working from home and take on a few clients. As they are doing everything themselves, their costs are non-existent, and their model is highly profitable. As they scale however, they can’t do everything themselves. They need to get an office, hire staff etc. Quickly the costs start rising but since your whole model is based on undercutting your competitors, you can’t compete.

Business is expensive, more expensive than you will initially realise. If your whole model is based on undercutting your competitors, for a small business you are going to struggle. Sadly, by undercutting for a couple of years and then going out of business, you bring the whole industry down which needs to find ways to compete with your pricing. I always encourage people to price appropriately from the start. If your competitors are pricing at a certain figure, it’s usually for a reason. The focus should be on the value you are bringing to the customer and not necessarily the price.

This post is from our resident Financial Planner Ben Brett, check out his details in the About Us section.

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Posted in: Ben Brett, Financial Planning