From the outside, entrepreneurship can look almost glamorous -- being your own boss, living life on your terms. What's typically overlooked is the nitty-gritty -- the long days, the stress, and the fact that as an entrepreneur, you're forced to wear a variety of hats, if not all of them. And one of those hats is money manager: You need to know enough about finance to avoid expensive blunders.
Here are six entrepreneurial money mistakes that are all too common -- and how they can be fixed.
1. Not Doing Anything About It
According to Jordan Merritt, founder and owner of Merritt Bookkeeping, which specializes in working virtually with small-business owners, the biggest mistake that business owners make with their finances is either doing nothing at all, or attempting to be DIY accountants without the proper tools and training. It's important to recognize where you need to invest in training to handle your business's books, or when it makes sense to have them managed professionally. If bookkeeping is not your thing, recognize the opportunity-cost of spending your time struggling through it, and instead hire a professional.
2. Commingling Business and Personal Accounts
Merritt says to at a minimum, entrepreneurs should set up separate business checking and savings accounts, and open a credit card to be used solely for business expenses. Using your personal accounts and cards for business expenses makes it hard to decipher what belongs where come year's end -- and you could end up losing out on valuable tax write-offs or making it more time-consuming (and costly) for your bookkeeper to get you organized. If you find your business running low on funds, transfer money from your personal account to your business account -- and then make purchases.
3. Focusing Solely on Income
Failing to look beyond your income statement could cause you to overstate or understate your income for tax purposes -- resulting in penalties or loss of income come tax time. According to Merritt, a balance sheet provides a snapshot of your business on any given date. What do I own and what do I owe? What assets increased or decreased and what liabilities went up or down?
4. Not Budgeting for a Variable Income
Having a variable income makes your personal and professional finances harder to manage. Entrepreneurs need to have budgets for both their business and the personal sides, and each spending plan should highlight at least five items that can be cut back on in lean months. Plan for slow months and ensure you have a three-month "living expense" cushion built up so you can pull from it when necessary and replenish in the better months.
5. Not Saving for Your Future Self
Entrepreneurs need to be diligent about saving for retirement, as they don't have employers to offer them sponsored plans or company matches. It's important to take advantage of the retirement plan options for entrepreneurs and look into setting up a SEP individual retirement account, a Solo 401(k) or SIMPLE IRA for yourself. It will save you money on taxes and ensure you have funds set aside for retirement -– assuming there will come a day when you'll want to stop working.
6. Not Protecting Your Income
Many people think "It won't happen to me," but the truth is, it could and it might. If you're a business owner, how would you or your family get by if you got sick or were injured, and couldn't work? Would you live off of savings? The average long-term disability claim in the U.S. lasts 34.6 months. How much do you have saved, and how long would it last? Not having insurance in place or having accrued enough savings to protect against a loss in income can damage your finances.
However you're tracking your finances on the personal and business front, know that it's easy to get started with both keeping organized and putting it away for your future self. Schedule a monthly money date to review spending, adjust categories, check on taxes and fund any necessary savings goals. And when it doubt, hire a professional to alleviate some of the stress.
10 Financial Land Mines That Can Decimate Your Net Worth
6 Ways That Entrepreneurs Accidentally Burn Money
Managed to get that raise or promotion? Fantastic -- now don't go out there and spend it all immediately. In classic "keeping up with the Joneses" fashion, too many of us see an increase in salary or a sudden windfall (like an inheritance) as an excuse to take our lifestyle up a notch. We buy bigger houses than we need, get the latest gadgets even though ours work just fine,and spring for fancy steak dinners just because we can.
Instead, whenever your financial situation gets a boost, consider the best ways to put that money to work for you. The truly wealthy are those whose money continues to grow and earn them more, even when they're not actively doing anything with it.
The average American household that carries credit card debt holds a balance of around $15,000. If you're among those who have a credit card balance, you've probably seen the little chart on your monthly statement telling you how much you'll pay in interest over the next several years if you make only the minimum payment. (If you haven't, look at it.) The same chart will also compare that to a "suggested" payment that's slightly higher.
Our recommendation? Throw everything you can at paying your balances off as fast as possible. And make sure not to take on any additional debt in the future; if you can't pay for a consumer good out of pocket, don't finance it.
We don't demonize student loan debt the way we do credit card debt because we see an education as an investment -- and higher education often is the difference between one income bracket and another. Similarly, many people justify taking out a car loan by stating that they need a car to get to work.
That said, debt is still debt, and the longer you take to pay it off, the more interest you'll pay. Once you've freed yourself of credit card debt, paying down your car and student loan balances should be next on your list.
Whether it's to handle an unexpected car repair, a sudden illness or a major plumbing problem, you should always have some money set aside to cover unforeseen expenses. Set up a regular monthly transfer from your checking to your savings account to earmark this money before you're tempted to touch it. If necessary, cut back in another budget category (like eating out or entertainment) to free up the funds to save more.
Putting aside a little each month could prevent you from getting socked with a hefty bill you can't afford and then need to finance.
No matter your age, you should be adding to your retirement funds -- such as your 401(k) or individual retirement account -- each month. Just setting aside money sporadically won't cut it; you need to identify how much you'll need to live on once you stop working and monitor whether you're on track to reach that amount.
Here's a quick-and-dirty rule of thumb: multiply your annual spending by 25. This is the amount you'll need in your retirement portfolio, if you assume that you'll withdraw 4 percent per year to live on during your retirement. In other words, you'd need $1 million in your portfolio to live on $40,000 annually. Creating a plan will help you make sure you're able to retire the way you envision.
A home is a big investment, and sometimes that investment doesn't wind up netting you the return you thought it would.
The biggest culprit is having too large a balance on your mortgage, which detracts from your own personal stake in the current market value for your home. The sooner you pay this amount down, the better your home equity will be.
You also want to be careful when purchasing a new home. Buying in a neighborhood that's on the downward spiral or buying the most expensive home on the block, likely won't net you a good return when it's time to sell. Also take care to stay away from custom renovations (like turning the garage into a recreation room), which could negatively affect your resale value.
Paying high investment fees eats away at your gains. And since your gains compound over time, this creates a domino effect that can really chip away at your wealth. Take a close look at your investment companies' fees and shop around to make sure they're not taking more of your money than they need to be.
If you don't have a long-term investment vision and are simply playing the market, you could seriously undermine your wealth-building potential. Stop paying attention to market fluctuations, media pundits and the stories of your friends and family. Instead, create your own long-term investment strategy that will maximize your overall returns. Resist the urge it play it ultra-conservative (or fall for get-rich-quick schemes) and educate yourself on the best way to make your dollars work for you.
If you're having trouble making sense of your options or want a second opinion, seek the help of a trusted financial adviser.
Based on your experience and seniority level, education and industry, you should have a fairly good idea how much you ought to be making at your job. If you don't, check out a site like PayScale to get a ballpark figure.
If you're not making what you're worth, you're doing more than leaving money on the table; you're also losing all the compound growth and investment returns that money could be generating for you. Invest in yourself with professional development and continuing education, make the case for that raise or promotion, or seek out a company who will value you higher.
If you don't have proper insurance coverage, you're taking a very big risk that could come back to bite you. Too many people think the worst can't happen to them, but the hard truth is you can't predict the future, and scrimping on sufficient insurance is never a good idea.
Of all the things we're hesitate to part with our money for, adequate insurance coverage should not be one of them. No matter your age, everyone should be properly covered with:
Homeowner's or renter's insurance.
Flood insurance (if you live in a flood-prone area).
Umbrella liability insurance (especially if you own a small business).
If a spouse or children relies on you for support, make sure you have a decent term life insurance policy, as well.