If a tree falls in the forest, but no one is around to hear it, does it still make a sound?
The same question goes for your business. If you don’t know how much money you earn and how much you spend, are you running a business or just playing business? Having a firm grasp on your numbers helps you determine if you’re actually building a profitable business—or if you just have a ridiculously expensive hobby.
If reading that last part made you feel defensive, I’m sorry.
But I’ve been there before. I’ve had that pit in my stomach and the harsh punch-in-the-face reality when I sat down one day and realized:
My business wasn’t profitable.
For me, I could no longer tolerate the cognitive dissonance that I was supposed to be helping people with their business finances when I was struggling to run a profitable business myself. So when I realized I wanted things to change, I changed the way I did things.
|In October 2017, I opened up a new checking account and called it my income account. It was new and novel and drastically changed my perspective on how I could build a successful business.|
In this article, I’ll show you how this simple account helped me increase my revenue by 132% in a single year—along with all the steps you need to copy my approach.
So what’s an income account?
An income account is a checking account that acts as a clearing account—a place where money gets deposited and then transferred out to other accounts. It only has one job: To be the checking account where all the income you earn gets deposited.
The trick is quite simple: Each week, I review my deposits and transfer money from the income account into my other accounts.
What other bank accounts do you need?
The three other accounts where my income gets transferred to are my operating checking account, tax savings account, and my personal checking account. Here’s a breakdown of each.
1. Operating account, or OPEX
I changed my old business checking account into my operating account, or OPEX for short. All of my business expenses get paid from this account with the exception of my personal salary.
Some of the things I pay for from my OPEX account include:
- Independent contractors
- Apps and software programs
- Business meals
- Liability insurance
- Business travel
- Business loan payments
- My cell phone
- Business books
2. Tax savings account
The tax savings account is where I save money for payroll and income taxes. It’s important to have a tax savings account so come tax time when your accountant tells you what the damage is, you’ll have enough cash saved to pay the bill.
Alternatively, if you make quarterly tax payments, you’ll be saving more of that money as you earn it.
Disclaimer: I’m not an accountant and this isn’t tax advice. When it comes to tax savings, please make sure to get counsel from your tax advisor.
3. Personal checking account
The last place I have income flowing to is my personal checking account, which is how I’m able to pay myself a real salary. Before the income account, I would look at the cash in my business account at the end of the month and pay myself based on what I had left and what I could afford.
There wasn’t always a lot left for me with this method.
After I started using the income account, I became committed to paying myself a percentage of income, not just whatever was left. This was a big change that helped me shift money away from operating expenses and into my personal pocket.
The weekly workflow
Every week, I sit down, log into my online bank and see how much money is in the income account.
Then I use a simple spreadsheet to help me keep track of how much I need to transfer. I recommend keeping a spreadsheet too. It’s good to have for reference and can be faster to look at than logging into your bank or bookkeeping software.
|Copy this spreadsheet into your Google Drive to get started ↓|
Disbursing the income is like dividing up a pie. I transfer:
- 18% of my income into my tax savings account
- 45% into the operating checking account, and
- 37% of my income into my personal checking account to pay myself
How did I pick those percentages? First, I asked my accountant for a tax savings rate. We landed on 18 percent. Then, I backed into the other two splits with a little bit of trial and error.
- I came up with an income goal that was based on what I wanted to pay myself.
- I broke down how much I’d need to earn every day to reach that goal.
- I analyzed my revenue streams. I looked at how much each stream was bringing in and what it would take to increase them to reach my goals.
- From that, I realized I needed to focus my efforts on growing the scalable part of my business and kill the parts that weren’t scaling.
I realized that I could make 45% work to meet the business needs and 37% for my personal income, leaving 18% for tax savings.
Do I have to do this exercise every week?
The reason why this is a weekly task, as opposed to monthly, is out of necessity. When I first started using the method, I needed to move money into my operating account to keep, you know, operating. After a while, it just became a habit and I started to enjoy the weekly finance time.
Also, isn’t your business worth investing even just a little bit of time caring about finances each week?
Pretty sure the answer is hell yes.
Why did this simple tweak work?
I limited my business spending.
When I decided I needed to pay myself first, instead of paying myself what was just left over, I was limiting the amount of money I put into my operating account. This meant I couldn’t rationalize excess spending as things that I could “write off anyways” because the cash simply wasn’t there to spend.
It illuminated my perspective. It gave me a new lens to view my business through. It protected me against myself and my spending impulses.
I call this phenomenon “Paco’s Law.”
|Amount you will spend = Amount of cash you can access|
The law states that your spending will equal the amount of cash you have available to spend. By limiting your available cash, you can reduce your expenses. Easy.
It was too clear to ignore.
My budgeting method also made it easy to see how I was coming up short and how that impacted both my business and my personal economics. I could reverse engineer the amount of income I needed to earn if I knew how much I wanted to pay myself and how much my business needed to operate. All of the parts of the equation impact one another. (It’ll be clear once you start to play with the equation.)
|Here are two examples based on my allocation percentages from above.
1. If I wanted to pay myself $3,000/month and I knew my business needed about $3,500/month, I first have to figure out how much the whole pie has to be in order for 37% of it to equal $3,000.
– $3,000/.37 is $8,108.11.
– Rounding up to $8,110, let’s see what 45% of that is and if it’s enough to cover the business’ monthly expenses.
– $8,110 x .45 = $3,649.50
Sweet, it is, since $3,649 is more than $3,500. Now onto another example.
2. Let’s say you need $6,000 for your business and $4,000 for your salary. We’ll start by manipulating the OPEX percentage to 50% instead of 45%. Then, we’ll see where the rest lands. (If it doesn’t work, then you can manipulate another lever, like total income, or allocations.)
– $6,000/.5 is $12,000.
– We’ll assume 18% for taxes or $2,160,
– leaving 32% or $3,840 for salary.
With the second example, you’re short on salary, but you meet the business needs.
Play around with the formula and make adjustments to the amount you pay yourself and the amount going to OPEX to figure out different monthly income scenarios.
Here are some examples of how you can change the allocation amounts to see how it changes the rest of the equation.
With $13,000 revenue, we’re right in the ballpark with these distributions:
- 49% going to OPEX is $6,370,
- 33% going to salary is $4,290,
- and 18% going to taxes is $2,340.
And with $12,500 revenue, the original distribution looks like:
- 50% going to OPEX is $6,250,
- 32% going to salary is $4,000,
- and 18% going to taxes is $2,250.
So based on the allocations above, monthly revenue should be between $12,500 – $13,000 in order to pay out a monthly salary of $4,000 and meet the monthly operating expenses of $6,000.
My moment of truth
After doing these calculations, I knew exactly what I needed to earn. That meant I couldn’t pretend to be blissfully ignorant anymore. And by revisiting it every week, I could check in to see if I was on target, falling short, or coming out ahead of my goals.
Confronting the reality on the regular also helps me be more mindful of my business finances in my day to day. My behavior changed because increasing income was at the front of my mind, not the back of it.
It sounds tough, but when you look at your business through numbers, it becomes too clear to ignore.
Warning: You might feel worse before you feel better
When you aren’t earning what you need to earn, you need to diagnose the issue. The issue can be one thing or a variety of things.
- It could be that your business spends too much money.
- It could be that your pricing is too high for the market you’re serving or too low for the market you want to serve.
- Or it could be that the problem you think you’re solving isn’t really a solution that people would pay for.
Using an income account will help you view your business through a new lens. You’ll be forced to be hyper-critical about how you spend and earn income. And if you need to make changes, having the details sooner rather than later will help you save time, energy, and lots of money.
Maybe even 132 percent more, just like me.