3 Financial Considerations for Setting Up Your Business

401(k) | Budgeting | Taxes & Tax Planning | Business Strategy | Tax Strategy | Business Planning | Business Partnership Planning

 Sara Gelsheimer By: Sara Gelsheimer

If you have a groundbreaking entrepreneurial idea floating around your head, then you may be wondering what to consider before starting a business. One simple mentality will help — the more planning you do upfront, the better off your new business venture will be. It's just like taking a vacation. You likely knock out all the logistical tasks first, such as reserving a rental car and booking your hotel. You may hunt around for the best deals on flights and accommodations. And that planning will pay off by saving you time and money.

Of course, much like with a vacation, there will always be moments that don't go as planned with a new business. But making strategic decisions before opening up your doors will help you avoid some of the common pitfalls. So, where to start? Unsurprisingly, finances are at the top of the planning list. Financial considerations for setting up your business, such as cash flow management and forecasting, should always be your baseline before going any further.

Why Financial Planning for Business Owners Is Key Before Opening

It's no secret that starting a business requires capital. Even so, your business may not provide income for some time. Knowing what resources you have on hand before you get in too deep can provide peace of mind that you'll have the funds you need to support your startup phase, or that you need to save more before you order those new business cards and call yourself CEO.

While it's tempting to get scrappy and assume you'll learn and create a financial plan for your new business on the fly, it's better to think ahead so you can avoid costly mistakes that you can't afford.

Creating a Financial Plan for a New Business

1. Do your prep work

Researching as much as you can before going into business is critical to your financial success. Of course, find out who the competition is, assess how many hours you'll need to devote to your business, and define who your target audience is. You'll also need to determine what type of business entity to create and operate under. There are several different business structures to consider — LLC, partnership, S Corp, or a C Corp — and the taxes and liability are different for each. It can be complex, so it's one area where it's beneficial to get assistance from an attorney or financial advisor.

When you know which entity to label your business as, you can determine how you'll be taxed. Because you won't be withholding taxes from a paycheck, you have to set aside money for taxes and likely pay quarterly estimated payments throughout the year. This will help you avoid any underpayment penalties, and prevent sticker shock in April when you'd have to write a big tax check otherwise.

2. Determine where your funds will come from.

Once you do the prep work and assess your current cash flow and resources, determine if you can or should finance the business yourself or will need outside capital. If you have the ability to finance the business yourself, you have the benefit of keeping control and keeping all profits – but you have to be prepared to make sacrifices particularly if you don’t have the funds to pay yourself an income for a time. If instead you decide to seek outside capital, look at your options and review the pros and cons.

Borrowing funds from a friend or family member, for example, can put a strain on relationships. Borrowing from a bank, on the other hand, can be costly due to interest rates and down payments. You could also go through the process of borrowing from venture capitalists and angel investors. Investors generally seek ownership so while you may save on interest versus a loan from a bank, you may also have to give up some profits and control. Ultimately, decide which route is best for your unique business — and especially financial — needs.

3. Consider Cash Flow Management and Forecasting

In addition, consider how to manage your cash flow, the anticipated amount, and when that cash flow will actually create a revenue stream to support growth. It's one of the common mistakes business owners make before starting their ventures, but it's very preventable with proper planning. For example, do research ahead of time to predict the average accounts receivable timelines for your industry. It will help you set better expectations. That, in turn, will help you work with vendors and line up those timelines so your accounts receivable comes in first. Remember to discuss payment terms with vendors and customers in the early stages of the relationship, and get them set up for electronic payments.

Once you get further along with your business, be sure to maintain accurate customer information, automate invoicing, and send invoices promptly. Schedule time once a week that's dedicated to assessing your accounts receivable and following up on past-due bills. This all works to make your cashflow more predictable.

Because business growth requires capital to support payroll, AR, inventory, and more, it's a good idea to establish forecasting models. These estimates are generally prepared every week, and they project expected inflows and outflows over a 90-day period to help determine whether a working line of credit could be useful to establish or if you'll need to find other sources of working capital.

4. Plan for your personal finances.

It's important to consider how to manage cashflow for your personal financial situation, not just what you'll need to operate your business and cover work expenses. One of the most common statements I’ve heard from business owners who left a corporate job is that going from a steady paycheck to having variable income is challenging. Having a good handle on your monthly expenses and savings to cover unexpected, non-discretionary costs can help offset the uneasiness that comes with this adjustment. Tools like Mint and YNAB (You Need a Budget) are great resources for budgeting and tracking this key financial information.

When you have a variable income, it is even more important to have an emergency fund in place. Your emergency fund should contain at least 3-6 months of non-discretionary expenses. It can also be helpful to list all of your expense and prioritize them – start with the most important and move to the less important (and likely more fun) things if your monthly income allows. And if you have an exceptionally good month, add some of the “extra” into your emergency fund.

There are so many things to consider before starting a business, so don't hesitate to reach out for help. A financial advisor, attorney, accountant, or business consultant may be able to help with your financial planning. And of course, network with other business owners to learn from them and the financial obstacles they've had to overcome. Running a business and its financials can be very daunting. It requires time, energy, and resources. But if you plan well now, you can reap the benefits in the future.

Additional Resources:

Check Out My Video Series - Common Mistakes Business Owners Make and How To Avoid Them.

1. No Worst Case Scenario Plan

2. Bad Cash Flow Management

Next Steps:

There are many complex decisions to make when it comes to finances. If you haven't already done so, we invite you to complete our brief 9-question financial assessment to discover your biggest areas of opportunity to improve your finances.

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Disclosure:

This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.

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Sara came to Plancorp in 2013 with a strong financial background and an even stronger commitment to financial education—particularly for women. A Wealth Manager and Founder of InspireHer (Plancorp's Women's Initiative), Sara is also a new mom. More »