Money and the Self-Employed: Part I- Starting Out
With no safety net of a regular salary, I have learned first hand on how to handle personal and business finances. Given that entrepreneurship is increasingly becoming a life choice for many, it would be opportune to share some of my experiences on the relationship between self-employment and personal finance (with equal application to those who are salaried employees):
Fact: Being Self-Employed takes a lot more money than you think (if you are employed, substitute business with a house)
Comment: I would make the analogy that creating a business is like buying a house. It takes a lot of money to start one and it continues to demand money all the time.
Things you can do:
- Budget, budget, budget. Figure out how much money you will require to start the business- do a financial projection on projected fixed costs (rent, utilities, salaries etc.) until you have enough sales for the business to pay its fixed costs. Got that figure? Now add it by 15-20% (speak to any contractor and a reno costs 15% more than the budget, the same should apply to starting a business).
- Decide on the amount of money that you will NOT use in your business. Personal observation teaches me that owner-managers will pour good money after bad into a business even if it is beyond the point of salvaging. Put aside money you will NOT use in the business and have the self-discipline not to touch it (put it in a separate high-interest bank account). The amount should be at least 2-3 months of your personal fixed expenses such as mortgage payments/rent, utility bills etc. (most guides say 3-6 months of your monthly salary which is a little unrealistic). If you do not have this money, start saving NOW and start the business when you have those funds. It provides a great cushion that you will not deplete all your money if things don't work out.
- Improve your credit score and get access to multiple sources of credit before you start your business. Banks lend money to small businesses based on the owner-manager's credit score not the business' financial health. I have been told that banks continue to demand personal guarantees from owner-managers who operate businesses with 20 plus years of healthy financial performance. Improve your credit score while you are still an employee. Obtain your credit score for free here or here. Correct any errors on your report or pay off as many late accounts as possible. Attempt to obtain lines of credit with favourable interest rates from your bank (banks love giving these out to anyone with a healthy credit score)- these are much cheaper sources of credit than credit cards and they can be obtained more easily while you have steady income. Once you obtain the line of credit, draw down on it even if you don't need the money and pay it off immediately- this will increase your credit score. The point is that people lend money based on your credit score so take steps to increase it now while you are an employee and have steady income to draw on. I have seen too many people who defaulted on their student loan, started a business and found no one would lend them money because of their past sins.