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Starting a business is expensive, so it’s super important for new business owners to focus on staying out of debt during the startup phase. Once they’re up and running, however, they may be tempted to loosen the reins on their spending and take financial risks before they’re ready.
The result? Vulnerable new business owners devoured by debt before their business hits the year mark.
Going into debt is one of the scariest things that can happen when you start a business. I’ve seen clients start off with a solid business plan, only to spiral into credit card debt within six months.
But staying out of debt isn’t as hard as it sounds. In fact, with just a few healthy cash flow practices you can safeguard yourself from debt in the first year of business and beyond.
Free Cash Flow 101 cheat sheet for small business owners.
Cash flow dos and don’ts to help keep new business owners out of debt:
Let’s start with the don’ts.
DON’T confuse profit with cash flow.
Profit and cash flow aren’t the same thing.
- Profit is your business’s financial gain. If you earn more than you spend on costs and expenses, you have profit! For example, say you earn $10,000 one month, and you spend $3,000 on the cost of goods sold and $2,000 on operating expenses. Your profit is $5,000.
|$10,000 – $3,000 – $2,000 = $5,000|
But earning a profit doesn’t mean you have positive cash flow.
- Cash flow is the cash that comes in and out of your business in any given time frame. While profit is connected to revenue, costs, and expenses, cash flow can be ANY cash coming in and going out of your business. This includes owner’s draws, partner distributions, credit card payments, and loan payments.
Many business owners forget to consider the money going out of their business that’s not related to expenses. For example, you have $5,000 in profit. You take a $4,000 owner’s draw. Then you need to pay $2,000 toward your credit card bill. Uh oh—you’re short $1,000!
|$5,000 – $4,000 – $2,000 = –$1,000|
See how quickly credit card debt racks up? Even if you’re profitable, you can still get into debt if you’re not careful about how you manage your cash.
DON’T spend money that you haven’t received.
Remember how we said cash flow is the cash that comes in and out of your business? By cash, we mean actual money received. Not money from a job you’ll probably get. Not money you’ve billed for. Not money you’re waiting on. Money that’s in your bank account.
I’ve seen many new business owners make spending decisions based on what they THINK they’ll earn. What they don’t realize is that customers can be flakey, contracts fall through, refunds are requested, and clients pay late. Then when they earn less than anticipated, they skip credit card payments or bills and take out loans to cover the deficit.
A good rule of thumb is don’t count on money until you receive it. Until then, it’s still hypothetical money that should be excluded from your spending decisions.
DON’T use a credit card unless you have a payoff plan.
Credit cards are a huge temptation for budding business owners. Cashback bonuses! Airline miles! Points for gift cards! Everyone wants to squeeze a little something extra out of their spending.
Yes, spending responsibly on a credit card can mean big rewards. But unless you’re certain you can pay off the full amount, unchecked spending can quickly become a slippery slope into debt. No amount of airline miles or points will make up for a credit card balance that has snowballed out of control—with interest.
Before you spend on a credit card, develop a payoff plan. The plan may be as simple as paying the balance in full, or it can be more complex if you can’t make the full payment right away. To pay off a credit card purchase over time, decide how much you’ll pay every month and for how long. Then set up an auto payment for that amount BEFORE you buy.
With credit card debt, people often intend to make payments and then get sidetracked by spending. The result? You only make minimum payments, slowly reducing the original debt while interest quickly racks up.
Bottomline: Don’t buy anything on your credit card unless you know exactly how you’ll pay it back.
DO check your upcoming bills before you buy.
Before making a major purchase, check your upcoming bills for the next 2–4 weeks to ensure you have the cash to cover the purchase AND pay your bills. Remember, bills aren’t just business expenses. These are also credit card payments and loan payments.
If you draw money out of your business for personal expenses, make sure there’s enough money after the purchase to cover your draws. Personal debt is just as much of a bummer as business debt.
DO make a plan for big purchases.
Whether you spend on a credit card or not, make a plan for any major investments in your business. Never make a big purchase impulsively. Slow down before you buy—it’s OK to wait.
A few tips:
|When making a big purchase…
Make a savings plan. If you don’t have the money for the purchase just yet, ask yourself:
– How long can you wait to make the purchase?
– How much are you able to save over time?
– If you make more money than expected, are you willing to divert some of that profit to savings?
Making these decisions early ensures you have the money when you’re ready to buy.
Avoid stacking expenses. If you already have the money for the purchase, look at your month ahead and assess when the best time is to buy. Generally, it’s not a good time to make a big purchase when you have a bunch of bills due. Aim to make the purchase when you have less outflow and, ideally, a surge of inflow.
Read the cash flow terrain. Finally, consider the seasonality of your business. Is there anything happening in the next three months that will affect your cash flow? For example, if you know the next month is your slowest, then it’s not a good time for you to buy even if you have the money!
Debt is the financial boogeyman for a new business owner, but with a little bit of thoughtfulness and planning, you won’t be cowering under the covers at bedtime. Instead, you’ll sleep well knowing that you’ve built a solid financial foundation for your business for many years to come.
The opinions expressed in this article are those of the author and do not necessarily represent Gusto’s views.
This article provides general information and shouldn’t be construed as financial advice. It’s always best to consult a CPA or financial advisor for advice specific to your business.