This post was adapted from an episode of the Teaching Tuesdays series. If you’d like to check out the video, you can watch it here!
Why is this important?
As a small business owner, you oftentimes receive income in big chunks and then don’t receive income for a while, or you’ll earn a lot more in certain months and a lot less in other months. What can happen is that your emotions start to mirror your income! When a lot of money comes in times are great – there is money to be spent because there’s a lot in your bank account. But when subsequent months roll around and you aren’t earning as much, fear, anxiety and stress creep in.
I want to help you set up a way to make sure this doesn’t happen, and that you can even out those peaks and valleys so you aren’t stressing out when times are bad, or getting overly excited when times are good.
How does it work?
The way that this works, first and foremost, is you need to figure out how much you want to take home and pay yourself every month. The best place to start with this is creating a personal budget so that you know how much you need to pay yourself every month.
Let’s say your monthly spending is $4,000. In this case you know that you’ll need to pay yourself a steady salary of $4,000 every month in order to cover those bills. Let’s look at a hypothetical example of how this works with variable income.
Say in month one you earn gross income from clients of $8,000. Then, in month two, you earn $6,000. Then in month three, you earn $2,000 in gross income. We aren’t going to take into account business taxes or business expenses, because that makes things a lot more challenging. But trust me, I’ll go into that in a future Teaching Tuesday because that’s a really, really important part to take into account if you don’t want to be chased down by the government, or you want to be able to reinvest in your business.
In month one, let’s say you make $8,000 and you pay yourself $4,000. That means there’s $4,000 left over that doesn’t have a job. What you want to do with that left over money is set it aside in a separate checking or savings account. So your client income or business income comes into a business checking account and then you move that extra money (after you pay yourself) into a separate business savings account.
The purpose of that extra account is to be your Variable Income Fund. When times are good and you make more money than you need to pay for your salary, money goes into that fund. When you make less, you can pull money back out.
Months 2 & 3
After month one, you now have $4,000 in that variable income fund savings account. Now month two comes around. You make $6,000, pay yourself $4,000, and now have $1,000 leftover that goes into that variable income fund. This means you now you have grand total of $6,000 in the pot
Month three comes around but this month you only earn $2,000 in gross income from clients! Now, rather than having to scrounge and worry that “shoot, I didn’t make enough money this month to cover my bills”, what you do is you take the $2,000 that you made in month three and also take $2,000 out of the variable income fund and use that to pay yourself a total of $4,000.
What the result looks like is that you paid yourself $4,000 in take home every month and still have $4,000 left over in that variable savings fund! Boom – no more emotions mirroring your income :). That’s the benefit of it. You now have this pot that you can look at and say “yes, there’s money in here, I’m good”. So, if and when you inevitably have a month where you make less than you take home, which is pretty common when you’re starting a business, you know that you have that money set aside and don’t have to question where that money to pay yourself is going to come from.
I know this was a really quick and down and dirty. But that’s the importance of having a separate savings or checking where you can put extra money when times are good and take money out of when times are not as good.
If you have any questions, I would love to hear what they are! Put them in the comments below send me an email at firstname.lastname@example.org.