From the June 1997 issue of Startups

Maintaining your financial equilibrium on the roller coaster of an erratic income.

Traveling the peaks and valleys of an up-and-down income can trip up the most savvy entrepreneur. One month you're buoyant as receivables are actually received; the next you're in despair as past-due accounts pile up. Yet, good month or bad, the mortgage must be paid and your family must eat.

What to do?

Right now, preferably before signing up your first client or selling the first widget (although after is OK, too; later is better than never), think through your objectives, develop both personal and business budgets, get a handle on your net worth, and be sure you have adequate reserves to tide you over.

Defining your goals is an essential first step. You have to know where you're going, both personally and professionally, before you can get there. Plunging ahead without thinking through your objectives is like setting out on a vacation trip in unfamiliar territory without a road map.

Break down goal-setting into three parts: goals, objectives and action. Goals are an expression of your values, a long-range look ahead at what is most important to you. As you start a business, is your primary goal to make enough money for a secure retirement? To form the foundation for business expansion? Or simply (or not so simply) to earn enough to support time with your family? Do you want to do something you love, even if you might make less money than you could by taking a job? Or is it important to you to make a lot of money?

Objectives are a step-by step path to your goal. Once you've clarified a long-term goal, a goal that may take many years to attain, you can break it down into specific objectives.

Action, the hard core of your financial program, is the here-and-now, day-to-day behavior that will make both objectives and goals possible.

For example: You are in your 40s, planning to leave a corporate job running a data-processing department to open your own word processing business. Your primary goal is to generate sufficient profits to ensure a worry-free retirement. That's a worthy goal, but it's both vague and long-term. It needs to be reduced to manageable objectives. Your specific objectives might include establishing a cash reserve adequate to support you during the first year of a start-up business plus developing marketing strategies to build profits over the long haul. The action you take to meet those objectives, and therefore your long-term goals, might include reducing expenses to build your cash reserve, seeking help from professional advisers in developing a business plan, and learning all you can about potential clients for the business you plan to start.

It's important to be flexible: If your research indicates that a word processing service won't yield more than modest profits, you'll have to either adjust your goals or get into a different business. If you're farther down the road and realize that your business won't produce the profits you need, think about enhanced marketing strategies or branching out into new arenas.

Annie Moldafsky, a successful writer in Chicago, decided a few years ago that her abilities to make real money as a writer seemed somewhat limited. Since she was being called on to do consulting assignments--and had a background in retailing and communications, strengths that could be packaged in a new way--Moldafsky decided there was more money to be made as a marketing communications consultant than as a freelance writer. But she built on her prior experience: "The credits I had as a freelance writer were crucial in developing my presence as a consultant. The fact that I had written on these subjects, and studied different areas, made me an expert."

If you have a salaried spouse, you may be able to start a one-person business with your spouse's salary as temporary backup. If you're on your own you don't have that luxury. Either way, even if your primary goal is doing something you love, you want your business to be self-supporting as quickly as possible. To make it self-supporting, you need a plan. And your planning should be realistic. Financial planner Diahann Lassus notes that "most people starting their own business lose touch with reality when doing their economic forecasts." On paper it all seems so easy. But having a much-needed product or service and actually finding the customers who need that product or service are two different things. Sending bills and collecting the cash are two different things, as well.

Many small-business owners overstate anticipated revenue and understate actual expenses. Remember this rule of thumb, often used by venture capitalists applying a cold, objective eye to hopeful start-ups: Divide revenues by two, multiply expenses by two, and if the business can still make it, you're OK. And be prepared for violent swings in income; very few self-employed people can count on a steady flow of cash.

On a day-to-day basis, managing your cash flow, both personal and business, is the most important thing you can do. Managing cash flow on the personal side includes monitoring income and outgo on a regular basis. It's the same on the business side, although a tad more complicated, since you must manage getting paid on time, think about things like depreciation, and satisfy Uncle Sam by keeping additional tax-related records.

The big issue, across the board, is understanding your own needs. Look at what you can realistically expect in terms of revenue and cash flow, and then look at your ongoing expenses. Consider the total picture in terms of best case/worst case scenarios and build in some margin of error. If your expenses total $2,000 in a given month and you're going to bill $2,000 that same month (but may not receive part or even all of the money for another month), you've got to figure out another way to live in the interim.

The key: tracking income over an entire year, then spending no more than the average earned in any one month. Any excess should be held in a reserve fund to cover inevitable shortfalls in income. Don't rush out to spend a nice big fee, in other words, until you are very sure about when the next check will arrive. And don't permanently upgrade your lifestyle on the basis of a temporary surge in income; selling your dream house after a couple of years because income declines can be tough, both financially and emotionally.

Preparing A Budget

"Budget" isn't a four-letter word. And a budget isn't a static document offering silent rebukes for failed efforts at money management. It is a working tool that helps you control expenses. Lassus calls it "expense planning."

Many self-employed men and women focus so intently on business plans and a business budget that they ignore personal financial planning. But you need parallel budgets, one for the business side of your life and one for the personal, if you are to achieve your objectives. Each budget should consist of two parts: an income-outgo (or profit-and-loss) calculation and a net worth statement (called a balance sheet in business).

The first part of your budget consists of an income-outgo statement for your personal life and a profit-and-loss statement for your business. Do both. In the end, the money may all flow in and out of a single pocket, but it's important to draw a line between your personal funds and your business funds. You need to keep them separate to satisfy the IRS. You also need to keep them separate so that you know whether or not your business is actually turning a profit. Blurring the lines only confuses the issue.

Remember to allow for the following items in your budget:


  • Taxes: The self-employed don't have taxes withheld from their paychecks, but that doesn't mean taxes aren't due. You will have to pay quarterly estimated taxes as well as have cash on hand to pay income and self-employment taxes each spring.


  • Benefits: When you have no employer to contribute all or part of the cost, you must provide your own vacation time, sick leave, health insurance, and retirement income. While it's tempting to put every spare penny back into your business, it would be shortsighted to ignore these needs.


  • Inflation: Put an inflation factor in your budget. When inflation is at four percent, you'll need four percent more income to live the same lifestyle a year from now; you will have to either beef up income or curtail spending. With luck and hard work, your business will grow by more than the rate of inflation, but do your projections carefully.

When income is erratic, you need an extra dose of self-discipline to make a budget work. Chart your income for at least six months, preferably for a year, then build up your savings by spending an amount no more than midway between your lowest monthly income and your average monthly income. Try to set aside some money from each check you receive, no matter how difficult it may be, to cover the times when there may be no checks at all.

Outline For Success

Use the outline format you learned in elementary school to structure your goals, objectives, and actions. For example:

I. My long-term goal is to make enough money to afford a comfortable retirement.

II. My short-term objectives, designed to help me reach that goal, are:

A. to establish a cash reserve to cover one year's expenses

B. to develop marketing strategies to build my business

III. The action steps I will take to achieve these objectives include:

A. reducing debt

B. finding competent professional advisors

C. conducting marketing studies to identify my customer base

Understand Yourself

1. Why are you going into business for yourself? Rethink it if your only reason is an inability to find a job. Go right ahead if you are utilizing specific skills, fulfilling personal interests, or have other positive reasons.

2. Where do you want to be in one year? In five years? In 10? Once you've made "enough" money, will you want to retire, or explore new interests, or expand your business?

3. How much money is "enough?" Have you set a target?

4. Does being a one-person business satisfy you? Or do you hope to expand, hire employees, and move into larger quarters?

From Financial Savvy for the Self-Employed, by Grace W. Weinstein. Copyright (c) 1995 by Grace W. Weinstein. Reprinted by arrangement with Henry Holt & Co. ($14.95, 800-488-5233).