How Small Businesses Can Be Profitable Amid Inflation
Inflation is at an all-time high, so it is a hot topic. We’ve seen numbers as high as 8-9%, while historically, inflation averages about 3% per year in America.
If you have a small business, you’ve probably seen your expenses rise. Consumers have also seen increased prices at grocery stores, gas pumps, etc. This can be very worrisome, especially because much of it is out of our control.
However, small business owners do have some control. You can control how you run your business, and you don’t necessarily have to be at the whims of inflation. That is one of the benefits of being a business owner!
I'd like you to please read below for our best tips for how to keep your small business profitable, even with sky-high inflation.
Segment Your Cash Flow System
Inflation affects your business budget because it raises the price of goods and changes what you can afford.
Most business owners assess their budget by looking at their bookkeeping statements, but these tend to be backward-looking and don’t do much to help us prepare for the future.
Instead, the best line of defense against inflation is to get your cash flow system (how you put aside money for your business) organized. Don’t worry; you don’t have to be an expert bookkeeper to do this.
We like separating business money into five separate bank accounts. Each account aligns with the main goals of your business:
· Income
· Profit
· Salary
· Taxes
· Operational Expenses (OpEx)
When all your money is in one account, it can look like you have a lot of cash on hand. However, this can provide a false sense of security because all that money may be required for paying taxes, business expenses, and payroll.
Instead, separating your money into different bank accounts provides a cash-based method to run your business that sets aside money for specific purposes. The system helps you know exactly where cash is coming into your business, which in turn helps you make better-informed decisions about your budget and change your behavior appropriately.
You may wonder why you would create all these different accounts. At first, it may seem like it adds complexity. However, we believe this system creates simplicity as you’ll become more in tune with where your money goes.
It is easier to look at your accounts and evaluate if you have enough money to buy things or make certain decisions. Retroactively looking at reports like a Profit and Losses Report can be harder. Over time, you’ll become less reliant on bookkeepers and CPAs. Instead, YOU will have the best knowledge of how cash is moving through your business.
How Should You Allocate Funds to Each Bank Account?
Exactly how you allocate your funds depends on your location, industry, business structure, and more. However, we can provide some good starting points.
First, set up your “Income” account to accept all of your sales, invoices, and revenue. This account will serve as the funnel or feed for all the other accounts.
Next, allocate funds to your “Profit” account first. We like starting with somewhere in the range of 1-10% of your gross income going to your profit account every month. This may be an uncommon practice for you. However, we believe that you should reward yourself for running your small business. The emotional benefit you get from rewarding yourself first is huge for small business owner morale. If you fund your expenses first and only give yourself what is leftover, you won’t sustainably build any wealth for yourself or your family. However, be careful not to confuse the profit with your salary.
Next, allocate funds to your “Salary” account. This account covers owner compensation or your salary. As a small business owner, it is important to pay yourself. This amount may range across the board but is usually around 10-50% of your gross income.
Next, allocate money to your “Tax” account. You want to put money away for taxes as soon as your money is made. This amount can change depending on your state, but 15% of gross income is a good starting place. You can also look at your previous tax return to see what percent of your gross income you paid previously.
Finally, fund your operating costs account, which we call “OpEx.” This might be about 30-65% of your gross income.
We believe every small business should start with at least the accounts above. However, you may wish to set up additional accounts for your needs. For example, you can create an account to save up for a big future purchase or business expansion.
Benefits of Creating a Cash Flow System with Segmented Bank Accounts
If you create a cash flow system with separate bank accounts for each business function, then you won’t need to pillage money from one business goal to another when prices rise from inflation. Instead, you’ll already have all the necessary funds properly allocated to each need.
This cash flow system creates a system of delayed gratification, so you have to stick with it. But if you do, then you’ll get better at knowing when to cinch down on expenses to prepare for rising costs. You’ll also find that you’ll be more responsible with your money because it becomes harder to “raid the cookie jar” or let expenses get out of control when you know exactly what your money is set aside for. It will also become clearer how hard inflation is actually hitting you.
How to Make Transfers Between Your Accounts
In our opinion, bank accounts with specific names and purposes are important. To help cut down on costs, find banks that allow multiple monthly transfers and don’t charge fees or require minimums for their accounts.
Some business owners prefer to create an extra layer of the organization by having their core accounts, like their income and operation expense account, with a different bank than their profit and tax accounts. Just so you know, it can take several days for transfers between different banking institutions, whereas transfers within an institution are usually instant.
We like making transfers to fund all of your accounts twice per month. The 10th and 25th of the month tend to work well, as this helps you pay payroll and monthly bills that are due on the 1st and 15th.
Bonus: Establish a Core Capital Account
To further protect your business against the effects of inflation, we like setting aside at least two months of operating costs. This provides a backstop in case of emergency or unforeseen circumstances.
This money should remain separate from other expenses. It should act as a cash reserve and should not be used to pay bills unless necessary. Instead, you should consider it a vault or rainy-day fund that helps you prepare for the unexpected.
Knowing that you have emergency cash on hand can take some of the pressure off and help you feel at ease. It can also help you avoid needing to go into debt by taking a loan or relying on credit to run your business.
You can either pick a monthly dollar amount or a small percentage to allocate to this account. Perhaps $500 per month or 2% of income is a good starting place. You can get a bit leaner in your operating expenses for a couple of months to cover this amount. Don’t “punish” yourself by taking away from your profit or salary account to fund this if you can help it.
How Do You Use This System to Pay Off Business Debt?
It is better to run a cash-based system instead of going into debt. However, we understand that isn’t always possible for small business owners. If you have debt in your business, and your main goal is to pay it off, you can use your profit account until the debt is gone.
Pay as much as possible towards your debt, but still, pay yourself at least 1% from your profit account. This is because the emotional effect of getting paid is important to give yourself momentum and a reward for working hard towards your goals.
If you need to, pay off the smallest credit card or loan first to give yourself positive momentum, even if it isn’t the highest interest rate. Your morale and sense of accomplishment are more important than anything else. To help pay off debts and maintain your profit, find ways to increase your profit or reduce expenses.
How to Build Wealth for You and Your Family
Every day, people who appear to have a successful business end up closing shop and going broke. Often, these people focused on building their businesses but didn’t build wealth for themselves or their families.
That’s why it is important to pay yourself a reasonable salary. It is also important to give yourself standard employee benefits and protections, such as retirement accounts, college funds, stock investments, health insurance, life insurance, and more.
This can be a huge challenge for small business owners and entrepreneurs, but using the segmented cash flow model described above can help you manage your finances to accomplish this.
Invest in your business and invest in yourself as well! This will make you more resilient to burnout, illness, unexpected events, inflation, recessions, and more.
