How To Manage Your Business Finances Effectively: The 50-30-20 Money Framework
As entrepreneurs, we face a multitude of challenges. Landing new clients, creating offers people want to buy, marketing your services, hiring and growing a team, turning a profit – the list goes on. But one thing we small business owners often overlook in our business is knowing how to manage our business finances effectively.
What should you do with the money once you get it?
Should you spend it, save it, or do something else?
How do you ensure that you have enough money for all your business needs?
It can come as a shock to realize that you need systems in place to manage your business finances but there is a simple way to do it.
In this article, I walk you through my preferred system for managing my business finances well – the 50-30-20 Money Framework. Keep reading to find out how you can implement this framework in your business and ensure you never have to worry about your business finances again!
Why is Managing Your Business Finances Important?
Amidst all the balls you are juggling as a small business owner, managing your business finances can feel like just another task on your to-do list. Yet, this is undeniably one of the most important things you can do for your business to ensure its longevity and long-term success.
While many entrepreneurs simply use their personal bank account for all incoming and outgoing transactions in their business, this is inadvisable for several reasons.
- Mixing business and personal transactions within a single bank account can open you up for an audit by the IRS.
- It becomes complicated to track your cash flow and ensure you have sufficient funds for expenses and taxes.
- Planning for the future becomes difficult without a clear picture of your business finances.
These problems (and more!) can be avoided by simply putting into place a system to manage your business finances. While there are a variety of options available, the 50-30-20 Money Framework is my personal favorite. It is simple to implement and effective in managing my business finances. That means I’m always on top of my money. This is also the system I recommend to my clients.
How to Allocate Your Business Finances using the 50-30-20 Money Framework
The 50-30-20 Money Framework is a simple allocation method for you to determine how to distribute your business profit. Here, we can think of profit as Income after Expenses. According to this framework, 50% of the business profit goes towards paying yourself, 30% to taxes, and 20% to reinvesting back into your business.
Disclaimer: The 50-30-20 Money Framework is a suggested guideline for business owners to think about managing their profits. These figures are not set in stone and can be adapted to meet different business goals. We recommend that you consult with your trusted financial consultant for advice specific to your business.
50%: Pay yourself
As the owner of the business, you deserve to enjoy the money you make! That’s why the first allocation and largest percentage of your profit should go towards paying yourself as an entrepreneur. I recommend taking 50% of your monthly business profit as your salary and/or owner’s compensation.
At the end of each month, you can transfer 50% of the month’s profit to your personal bank account. Doing this is important for two reasons.
1. It allows you to keep personal and business transactions separate.
Your personal expenses and spending can be done out of your personal bank account without having to worry about keeping track of receipts. This is useful to avoid getting into trouble with the IRS at tax time.
2. It removes the guilt many business owners feel about enjoying the fruits of their labor.
Many business owners and entrepreneurs feel guilty about making purchases for themselves or spending money on their wants and desires. They often believe that they need to live on the bare minimum and reinvest everything else back into the business. However, this is unsustainable in the long run and can lead to resentment towards the business! Transferring 50% of your business profits to your personal bank account as your salary helps prevent this from happening.
30%: Pay your taxes
Taxes are often a large expense for business owners. The average small business owner can expect to pay about 19.8% of their income in taxes. Without careful planning and money management, you could end up in a situation where you don’t have enough cash set aside to pay your quarterly estimated taxes.
Save yourself the headache and stress at tax time by following the 50-30-20 Money Framework: Set aside 30% of your monthly profits for taxes. When it comes to taxes, it is better to err on the side of caution. Underpaying your quarterly estimated taxes comes with penalties from the IRS, so avoid getting into that situation by setting aside more than is strictly necessary for your taxes.
It is a good practice to transfer 30% of your monthly business profit to your business savings account. That way, you can be sure that this money is safeguarded for paying taxes and that you are not accidentally spending this money.
20%: Reinvest into your business or keep it as profit
After allocating 80% of your monthly profit towards paying yourself as the business owner and paying your taxes, you are left with 20%. This is the portion of your profit that you can reinvest in your business or put aside for profits.
It can be convenient to leave this last 20% of your profit in your business checking account. This makes it easier to keep track of expenses as you pay vendors, purchase necessities for your business, and make other payments for your business.
Reinvesting in your business is a crucial part of helping your business grow and expand. If you decide to work with a coach to improve your sales, that would come from this fund. If you need to hire an accountant to sort out your taxes, that would come from this fund too. If you need to purchase a new laptop for your business, that would come out of this as well.
There may be some months when you do not have any expenses or do not spend the full 20% set aside for reinvestment in your business. That is normal. Keep the money in your checking account so that you have cash on hand for larger future expenses that may come up. Over time, the months where you spend more and the months where you spend less will balance out.
You may also choose to record the funds in this account as profit at the end of each quarter or the end of the financial year. You may then decide how to make use of the profit your business has generated.
Profit First Method vs 50-30-20 Money Framework
Profit First is a popular method for managing business finances but many small business owners tend to struggle with it. The Profit First method is complex and involves setting up five different business bank accounts that you use to organize your funds by transferring money to those accounts each month.
For entrepreneurs and small business owners, it can feel overwhelming and challenging to set up and keep track of five bank accounts. In my experience, when the systems we use are more complicated than we need, we simply stop using them. I have met many small business owners who start off using the Profit First method but eventually cannot keep up and abandon it.
That’s where the 50-30-20 Money Framework that I recommend has an edge. It is much simpler to implement and use for small business owners. With only three accounts to keep track of (and one of them is your personal bank account!), you can easily stay on top of your business finances.
This system is also robust enough to meet the main requirements of small business owners and can be adapted to a business of any size.
Benefits of Managing Your Business Finances with the 50-30-20 Money Framework
Once you implement the 50-30-20 Money Framework in your business, you will soon start reaping the benefits.
- Intentional allocation of funds: No more simply “going with the flow” when it comes to managing money in your business. This system allows you to take control and direct funds to the important things – a kind of automatic “budgeting” that makes it easy to keep track of your finances.
- Becoming more financially prepared: Ups and downs in business are normal, but our regular expenses remain. Implementing this framework helps you be prepared for unforeseen emergencies and to weather the highs and lows in business.
- Having money to invest in growth: Without the proper management of your business finances, you may not have enough cash to invest in systems, tools, and support that will propel your business to the next level. This framework ensures you always have sufficient funds to invest back into your business growth.
- Be prepared for taxes: Not having enough to pay taxes will be a thing of the past and you will definitely have enough cash to pay your quarterly estimated taxes without stress and worry.
- Incentivize yourself: Money is a great motivator but too often, small business owners do not pay themselves. This can lead to resentment down the road. This framework takes that into consideration and ensures that you are reaping the benefits of your hard work!
Are you ready to get on top of your business finances by implementing the 50-30-20 Framework in your business? Learn how you can make this effective system work for you with the Exceptional Tax Services 50-30-20 Framework Calculator: Download it here for free!
