Can You Run a Small Business Without Debt?
Being your own boss is both liberating and exciting. However, many resources and business experts will encourage you to take out a business loan in order to buy the right equipment and get ahead of the competition. In my experience, doing this can push your business to grow before it's ready. At the same time, that debt can cripple your personal life and be detrimental to your business.
To avoid this dilemma, here's how to start and run a business without debt, so you can build the best financial foundation before taking off.
1. Calculate your average monthly income
The first thing you want to do is figure out your average income is each month. This can be difficult when it fluctuates from month to month but it's a vital part of your financial success.
Start by adding up all the money you made from the last quarter, or over the last year, and divide it by the same number of months to find the average. This will give you a solid number to work with when creating your business budget.
If your self-employed income varies dramatically, use the lowest income month as your baseline number. For example, if one month you made $3,000 and the next two months you made over $6,000 each month, it’s best to use the $3,000 figure as your baseline. That way you won’t get caught off guard when you have too many low-income months with high expenses.
2. Separate wants from needs
Estimating your expenses is a little easier as a business owner than estimating your income. Start off with the most important things first -- your needs. These are things that are essential to running your business. Next add in your list of wants, or things you'd like to have for your business but don't necessarily need for it to keep running.
The total of your wants plus needs will create your overall expenses figure. You always want to separate your wants and needs in the event you have several low months of income, and can only pay the essentials.
If this happens multiple months in a row, you might need to consider finding areas in your budget to cut back on even more, otherwise you need to find more revenue. Banking on making more income each month just causes you stress and anxiety.
3. Plan for big windfalls ahead of time
What about those months when you land a big project, or get a bonus from closing a deal? What should you do with big windfalls? Create a plan ahead of time, by dividing bonuses into three categories:
- Saving
- Investing
- Goals
One of the most essential things to have when you’re self-employed is a “feast and famine” account, just in case. You only touch this account when you really need it to cover emergencies or other essential needs. Having this account will make you feel more secure about your overall financial picture, and help you get by in the hard months -- without having to use debt for leverage.
If you already have a feast and famine account in place, then your big windfall can be invested for the future of your business, buying equipment or put towards your long-term goals.
4. Set aside 25% of your income for taxes
Since you're the boss now, you won’t have taxes withheld from your paycheck like you would at your regular job. And since the IRS requires taxes to be paid, “at the time the income is earned” you’ll most likely have to make estimated tax payments every quarter, also known as QET’s (quarterly estimated taxes).
Depending on the state you live in, it’s a good idea to set aside at least 25% of your income towards paying taxes. I actually set up a separate savings account called “income taxes,” and at the end of each month I calculate 25% of the income my business made that month and transfer it over to my income tax account. Then every quarter, when it’s time to send in QET’s, I have the money set aside.
5. Only buy what you can afford
This step may sound like a no-brainer but it's worth a reminder. If you're ready to, or really need to shell out some money to hire or buy supplies, only do so if you can pay for the purchases outright.
This is why it's vital that your business has some money saved up, for emergencies and growth expenditures. If you use credit cards and business loans as an extension of your income, it's a recipe for disaster. Nothing will sink your business (or your personal freedom) more than having debt weighing you down.
Create a plan to live within your means every month, and only use debt products as a means to an end. Don't rely on them forever as they can become a crutch.
If you follow these simple steps you'll be able to build a business without debt and have no problem paying all your bills, dealing with windfalls and paying taxes. You'll watch your business grow organically and it will be well on its way to a successful business!
