YOUR FINANCES
Smart Cash
Flow Management Can Make You Rich
As a small business owner, you know that the most precious
commodity you can get your hands on is Free Cash Flow. That’s
the money a company has left over after it has paid all
of its operating costs and other expenses. Smart business
owners reinvest some or all of this money to generate long-term
growth for their companies.
What too few business owners do, however, is think about
their personal cash flow in the same terms. But they should.
Just as investing free cash flow in new machinery or an
extra salesman will help your company grow and create greater
long-term value in the business, you can build your own
personal wealth by investing your own free cash flow.
There are three primary ways to maximize personal cash flow:
- Pay no more taxes than you need to,
and invest the money you saved from the taxman.
- Use debt smarter to preserve current
cash flow and invest the difference.
- Refine your lifestyle spending without
depriving yourself, and add the money saved to your investment
portfolio.
We will discuss tactics for maximizing
cash flow in subsequent articles. But before we do, I want
to illustrate another critical point, which my financial
planning firm calls integrated cash flow management. Typically,
people try to separate personal and business finances. Yet,
for the business owner, investing for retirement, tax planning
and business budgeting are related. And which sources of
cash you use for which expenses can make a difference. Consider
these examples:
Paying For Your Personal
Financial Plan
As you’ll recall, I advised in a
previous
column that you should create a personal financial plan
that will help you expand your business and build your personal
wealth. You should start with a personal plan, then create
or refine your business plan to support it. For this, you
should seek a financial planner who is also a CPA and can
handle both plans.
So, when it comes time to pay the planner,
which checkbook should you use your personal checkbook or
your company’s? Most small business owners assume
that because a personal financial plan is “personal”
they must pay the financial planner with a personal check.
Not so!
Because it is imperative that any small
business owner’s business plan be aligned with his
or her personal financial plan, the planner’s fee
is a legitimate, deductible business expense.
What’s more, it can cost you dearly
to pay from your personal account. Say you hire a financial
planner and his fee for meeting with you, putting together
your personal financial plan and helping you implement the
plan is $7,500. If you are in the 40% tax bracket, and your
business writes the check for your financial plan (assuming
you have an S-Corp or an LLC business), your net cost would
be just $4,500 (the $7,500 less 40% in tax savings), because
the plan is a business expense. (And what do I recommend
you do with that newfound $3,000 in free cash flow? Right!
Add that money to your investment portfolio and speed up
reaching your wealth goal.)
On the other hand, were you to pay with a personal check
it would cost you $12,500 (That’s the amount of earned
income you would need to generate $7,500 after taxes.) As
you can see, smart cash-flow management can make a significant
difference in helping you hold on to more of your money.
Paying For Your Disability
Income Insurance
Let’s now consider how you should
pay for your disability income (DI) insurance. It’s
another example of where the right choice is not obvious,
but the wrong choice is rather costly.
First let me emphasize what I tell all
my small business owner clients: Unless you have already
achieved financial independence, DI insurance is a “must.”
Without it, you may have nothing to fall back on if you’re
sidelined by injury or disease.
So what’s the smarter way to pay
your annual premiums: with a company check or a personal
check? Like your financial plan, a DI policy counts as a
legitimate business expense. So, the business should payright?
Wrong. And, again, the reason is taxes. Let’s say
you determine that if you were to become disabled you would
need $60,000 a year to cover your basic living expenses.
So, you have your company buy a DI policy that would pay
out $5,000 a month while you were disabled. Again, let’s
assume you are in the 40% personal tax bracket. In the eyes
of the IRS, if your company foots the bill for your policy,
the $60,000 a year would be considered taxable income, like
wages: Uncle Sam would take $24,000 ($60,000 x 40%), leaving
you with only $36,000 to cover your $60,000 worth of annual
living expenses. Ouch.
If, instead, you should pay the DI policy’s
annual premium with a personal check, then every penny the
insurance company pays out would be tax-free.
As these two examples demonstrate,
an integrated approach to cash flow management can help
you build wealth in your business and in your personal portfolio.
Guy McPhail, CPA, CFP®,
is president of Zdenek Financial Planning, LLC.
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