When starting a small business, there are many financial considerations to take into account. Yes, defining and marketing your services is a big piece of the puzzle but in order to make a sustainable income and operate compliantly, finances should be taken into account as well.
Here are six financial management topics that you’ll want to review before launching your company.
1. Desired Income and Bill Rate
When starting your business, it’s a good idea to set a goal for your desired amount of income. That number will dictate many important decisions as your bill rate, business purchases you make, and type of clients you target.
With your desired income number in mind, you’ll want to consider what your bill rate is—how much you plan on charging clients. There are a few ways to calculate this number such as the cost-bate method which takes into account the costs you need to cover to make your target income, the market-based method which takes into account supply and demand of your services, and the value-based method which takes into account the value you provide to your client. To play around with different numbers, check out MBO’s bill rate calculator.
As an independent contractor, paying taxes will be different than what you are familiar with. You should plan on playing at least 30-35% of your gross income in taxes. These include: income tax (per your tax bracket) as well as both halves of Social Security and Medicare (FICA). This is also known as the self-employment (SE) tax.
You will also be paying estimated tax payments quarterly. Because taxes are not taken out of payment you receive from a client, paying taxes quarterly helps to eliminate paying a huge tax at the end of the year. To file your taxes, you’ll generally use form 1040-ES, Estimated Tax for Individuals to calculate and pay these taxes. This form contains blank vouchers you can use to mail in payments, or you can make payments online using the Electronic Federal Tax Payment System (EFTPS). If you are not familiar with paying taxes as an independent contractor, it is always helpful to consult a tax expert to get your questions answered—especially the first time around.
Running your own business means that you get to choose what you invest in. While it can be tempting to outfit a new office with the latest technology and comfy furniture, you’re better off playing it safe and only buying what you truly need when you first start out.
While high-quality technology might be a necessary purchase, a top-of-the-line ergonomic chair might not be essential. Before making any big purchases set a budget for yourself and list out what you truly need. Be sure to consider what reoccurring expenses you’ll have as well such as office supplies or software subscription renewals.
One of the biggest perks to working independently is better work-life integration. While your choice of vacation time might sound great in theory, it is often harder in practice. It can be difficult to turn down work to take time off, or put a hold on projects to take a trip. But keep in mind that working long hours and through holidays can lead to exhaustion and burnout, and defeat one of the reasons you went independent in the first place.
Taking time off is a matter of planning ahead. That means letting clients know well ahead of time when you are not going to be available and putting in some extra hours if needed. Be sure to set boundaries with clients so they know what to expect but also how to reach you in the case of an emergency.
5. Payment Terms
If you’re new to independent contracting, you might not be familiar with payment terms. Payment terms are typically established in a contract or Scope of Work (SOW) and outline when and how a client will pay you. Typically, the bigger the client the longer the payment terms. Typical payment terms are around 30 days, but larger clients may have payment terms up to 90 or 120 days.
This is important information to take into account, because you won’t get paid for your work immediately when you finish it. Consider payment terms when managing your cash flow and make sure you have enough operating capital coming in to stay on top of your expenses.
6. Business Credit
Business credit is a track record of a business’s financial responsibility that companies, investors, or financial organizations use to determine whether or not that business is a good candidate to lend money to or do business with. Good business credit can help you grow your business because it will give you better access to loan terms, insurance premiums, or credit line increases. If you’re considering any of these methods for financing your company, business credit is something you’ll want to be aware of.
There are many ways to build business credit including establishing trade lines, which involves purchasing items for your business through suppliers who you pay back at a later date, and applying for business credit cards and paying them on time.
The information provided in the MBO Blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO Blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.