It was the most boring class I took in four years of college, but nearly 15 years later, the most important lesson from the first day of Introduction to Accounting stays with me. The professor, a partner at Price Waterhouse and Coopers, stood in front of the class and said, more business go out of business not because of a lack of customers, but because of a lack of cash flow. The most important question to the success of a business is: Does the cash flow?" I can hear it in my head just as clear as if it was yesterday.
Today I write this because it's a lesson that has stuck with me and provided the backbone of the financial management of my nearly six-year-old photography business. And after some trial and error, I'm fairly certain I have it sorted out. In one sentence, the solution to never being cash-flow negative is to live below your means for most of the year. And if you do that for a few years, the financial security you'll build will become the rock that backs the future strenth of your business.
Like most things related to running a small business, I try and keep it simple, so I'll explain via examples. Between state and federal taxes, I owe roughly 25% of my net income to the government. Net income, that's key. Net income is the money you keep after you've paid your business related expenses, while gross income is the total amount of money paid to your company. However, because even though I owe 25% of my net income, I set aside 35% of my gross income for savings. Let's use some real numbers, which I think will make this easier to follow:
A client hires me for a shoot and agrees to pay me $1,000. I know that of that $1,000, I need to set aside $100 to make the album included with their project. So the goverment says that from this, my profit is $900 and I owe them $225 (25% of that). However, I set aside $350 in my tax savings account (a separate savings account that I use to pay taxes from) and then $100 into my cost of goods sold account. Of that $350, $225 is for taxes and $100 is for my retirement accounts, which I contribute to quarterly. So now I've created a surplus of $25 in my tax savings account ($350 - $100 for retirement - $225 that I owe the government.) Over the course of the year, these tiny surpluses add up to a significant amount of money, and every April after I pay my taxes, that surprlus is my annual bonus. Add to that the fact that my separate cost of good sold savings account houses the money I need to purchase products for clients down the road, and combined they ensure that I'll never be cash flow poor.