The standard operating procedure (SOP). If you are a business owner you have craved for these to be part of your business. Here are a few examples of SOPs you have probably wanted in your business.
- Employee onboarding SOP
- Customer onboarding SOP
- Customer service SOP
- Phone answering SOP
- Customer satisfaction SOP
You are probably reading this and fall into two categories. I wish I had those. I am glad I have those. These are the same two categories for your financial life. In this blog, we are going to break down the standard operating procedure for your income.
As income grows above and beyond your lifestyle you need further direction for it.
- Do I reinvest in my business?
- Do I buy a 2nd home?
- Do I max out our company 401(K)?
- Do I upgrade my lifestyle?
- Do I save for retirement?
These are all valid questions that don’t always have the most straightforward answers. Let's break into how we frame income planning for business owners at Moment.
Standard Operating Procedure for Income
Bucket 1 – Your Business
This is the lifeblood of your income. Without your business, you have no income. As they say, cash is king.
It is the one thing you cannot run out of in your business.
This is where we start the income planning discussion. These are the questions we ask business owners who work with Moment.
1) How are you using the cash in your business?
2) Does your business growth strategy require cash?
3) How much money do you need in your business to fund the operation?
Once we can answer these questions we can determine what needs to stay in your business vs what we can take out. Often we see business owners with significant cash positions in their business. There is nothing wrong with this as long as you have a plan.
With the amount of cash determined for operating and growing your business, we shift to your personal financial life. This starts with bucket 2.
Bucket 2 – Emergency Fund
Once we have established how much cash we need to keep in your business we switch to your personal balance sheet. First up is your emergency fund. In order to determine how much needs to be in your emergency fund we need to know how much it costs to be you.
If you don’t know you need to start tracking it. Yes, this means you need to track your spending. Thankfully there are many great tools out there to make this easy for you. If you don't know what it costs to be you it is difficult to determine how much needs to be in your emergency fund. The worst thing you can do is put yourself in a vulnerable cash situation that is dependent on your business as your one income stream.
So how much cash should you keep? The true answer is it depends, but as a good rule of thumb, we recommend 6 -12 months' worth of living expenses. This should give you enough cushion if things start to go sideways in your business.
Bucket 3 – Retirement Savings
Once we have established your personal and business cash position we should start looking at investing money on your personal balance sheet. This starts with retirement savings. It is key that we get the first two buckets right before we move to the retirement buckets. These are going to be long-term investments.
When we think about bucket 3 we are going to break strategies into two buckets. The first bucket provides us a tax benefit today and the second bucket provides us a tax benefit in the future.
Accounts with a Tax Benefit Today:
- 401(K)’s
- IRA’s
Account with a Tax Benefit in the Future:
- Roth 401(K)’s
- Roth IRA’s
So how do you determine if you should be investing for future tax benefits or current year tax benefits? It depends on a number of different factors.
- Your Age
- Your Tax Rate
- Your Timeframe
This decision will be specific to you, but it is key to get it right. Investing in the right retirement accounts will save you thousands in taxes over the course of your life. To do it right you need to have a plan and consistently execute that plan.
Bucket 4 -Taxable Investments
Bucket four is going to be the main driver of your financial flexibility. Think about this as your most liquid investment. These are traditional brokerage accounts where you invest in the stock market. This bucket is a key to financial flexibility. At the end of the day, you are running your business with the intent to create freedom of time.
The most common mistake I see is a business owner pouring all of their additional funds into a brokerage account with no plan. Then a year later they decide they need to pull these funds out to grow their business, invest in real estate, or fund their lifestyle. This is a long-term bucket. This mistake often leads to selling at inopportune times. Funds that are invested in the stock market should be earmarked for long-term growth.
With all these factors how do you determine how much income should be allocated to bucket four?
- How much money do you need in bucket four to meet your goals?
- How long do you have to save in order to meet your goals?
- How much additional income do you have left after funding buckets 1-3?
This last question is a fundamental guide to meeting your goals. If you have an excess of a million dollars after funding buckets 1-3 it doesn’t mean all of these dollars need to go into bucket 4. Rather it is an art, not a science.
So if you have additional funds left over after bucket 4 where do these funds go?
Bucket 5 – Private Investments
Private investments often get prioritized too fast for business owners. After all the fastest-growing asset you own is your privately held business. What many entrepreneurs fail to realize is that their asset allocation is already severely shifted towards private investments.
Let me explain.
For those of you reading this that haven’t exited likely your largest asset is your business. If I looked at your asset allocation I would take this into account and see that you already have a large allocation to bucket 5. This is why we prioritize this last when we are allocating income from your business.
Although private investments will have the highest chance for outsized returns remember there are cons to private deals.
- Risk – You can lose 100% of your investments.
- Liquidity – Your money is locked up and can’t be accessed.
- Time – Typical private deals have a 5 – 10 year time frame.
These are all reasons to be cautious entering the marketplace but also the reasons why we would expect to get outsized returns.
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Managing income is hard. As a business owner, there will always be somewhere you can invest money. The key is having a plan and sticking with it, if you are struggling with income planning that's ok. Moment Private Wealth was created to specialize. We have financial advisors for business owners like you who have walked in your shoes.
Our goal at Moment Private Wealth is to help you avoid these common mistakes. This is why we help with income planning for business owners. It isn't enough to know what tools to use but you need a team to help you implement.
If you are an entrepreneur who is concerned about income planning, schedule a call, and talk with a Moment founder.
Not sure what questions to ask, check out this video on 10 questions you should ask when interviewing a financial advisor.
Get in Touch With An Advisor
*Moment Private Wealth offers information on tax and estate planning that is general in nature. Tax and Legal advice are not provided by Moment Private Wealth. Consult an attorney or tax professional regarding your specific legal or tax situation.
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