Keeping track of business turnover and expenses is an important part of running a business. Perhaps your target is to increase profits month to month, year on year. But does an increase in profits always make you better off financially?
There’s a concept known as a ‘lifestyle creep’, which can easily trip you up. It works like this…
As you earn more, the things you previously thought of as luxuries gradually become necessities. You buy groceries at more expensive shops, eat out more at pricier restaurants, buy more expensive cars, gadgets and gifts. Extra income earned gets lost in an ever increasing standard of living. Your hard work shows up in more material goods or lavish experiences. You may appear, or feel, richer. But these often become liabilities to maintain and won’t increase your net worth. This enhanced lifestyle doesn’t secure your future or buy you freedom. In fact, you’re just increasing the demand on your future self to produce an even greater income to satisfy this new level of expectation.
In our post – How to de-stress your business finances – we talk about the importance of separating out business and personal finances and making sure enough is saved for tax and national insurance. But, no matter what you generate from the business, you won’t create financial success unless your personal spending is kept in check. Earning more isn’t always the answer.
Personal spending plays a big part in what you need to set as a target to generate from your business. The more able you are to personally manage on less, the more likely you are to make the business work for you. If you resist the urge to allow your lifestyle to creep up as you earn more, you’ll have more to allocate for your future plans. Plus, the size of pot needed for your financial freedom in the future won’t need to be nearly as big.
So, how do we resist this lifestyle creep..?
Pay yourself first
The answer is automation. Simple in principle and easy to apply. It just takes a decision to make it a priority. Once in place, it’s then easy to maintain and review.
Don’t wait until your earnings increase, until the kids are off your hands or until you’re sure that you can afford to save. Set up a system to automatically sweep money each month into different pots for your future. That way, while still focussing on increasing your turnover and profits, you can trick your unconscious mind into thinking that you’ve got less money available to spend. And, before you know it, you’ll have built up decent reserves.
You reap what you sow
Everything has a cycle. You sow, cultivate, then harvest. Conspicuous consumption would have us believe that you can jump straight to the harvest by buying now and paying later. But we disagree. It’s possible to cultivate good or bad habits.
Here’s our top five tips for developing good habits:
1. Draw enough to cover your personal spending: To start with you’ll need to know where you are. Take a look through bank statements and work out what you need on a monthly basis for personal spending. Go through your direct debits and standing orders with a fine-tooth comb and see if there’s anything you can cancel or reduce. The less you need personally, the less pressure on your business and on you. Once clear, decide on a monthly fixed payment from your business to pay yourself and set that up with your bank. You should take advice from your accountant when it comes to salary and dividends to make sure you’re being tax-efficient.
2. Make an allowance for occasional costs: Some expenses don’t crop up every month. Set aside a fixed amount each month to cover these from the personal spending money you pay yourself and also within your business (a good habit is to have separate savings accounts for both of these). This could help you pay for things like holidays and gifts, as well as irregular business costs such as new equipment or training. These pots could also be used for occasionally rewarding yourself, or the business, when you hit or exceed your target income for example. Just don’t make rewards a habit as it can easily lead to a lifestyle creep.
3. Make payments to your future self: Decide on an amount you’d like to put away for your future self. Seek advice if needed on things like investments and pensions and ways to take advantage of tax breaks. Then fix payments into different savings and investment vehicles (for example, ISAs, SIPPs or property funds), so that the money starts building up in these pots without you having to think about it too much. It’s important to begin to build this habit, as a small amount each month will build into something meaningful, and this will cement the value of the habit in your mind.
4. Focus on a monthly turnover target: Once you know what you need to cover personal spending, occasional costs and payments to your future self, you can quickly work out what profit you need to generate from your business. Add in business costs, an allowance for tax and national insurance, and you’ve got yourself an income target. Don’t just do the maths. Post reminders on your computer or on your wall. Focus on it daily. Share it with people whom you trust to hold you accountable and who have a genuine interest in you and your business.
5. Become your own Angel (Investor): As your business generates higher profits your vision may expand, or new unplanned opportunities may appear. Make sure you set aside money within the business so that you have the cash needed to take it to the next level. This may seem instinctive, but people often forget to operate for success. It’s a good idea to ask yourself how far you want to take the business. Are you planning for that vision? What’s especially good about operating in this way is that, should things take a turn for the worse, you’ll have a safety net to weather the storm with less stress.
The quicker you develop the habit of paying yourself first, and resist the temptation to spend more as your earnings increase, the sooner you’ll be able to create financial freedom. By prioritising your future self, you can maximise efficiency with your savings and live a comfortable lifestyle on what’s left. A great life lesson to pass onto future generations.