3 Questions to ask yourself before you start your own business.
Before I started my business there were 3 things I wanted to know before I felt confident enough to start out on my own.
- How much cash do I need to spend personally?
- How much do I need to earn to be able to spend that money?
- How long will it take to get to that level of earnings?
You see many people seem to think that if they don’t immediately replace their own paycheque they can’t start their own business. The only time this would be the case is if you are living paycheque to paycheque. And even then, perhaps a good look at your personal spending habits could mitigate this problem somewhat (just saying!)
The first one is pretty easy to work out. You are going to need a household budget. How much do you NEED each month to live and how much do you need to save each month to cover the non-monthly expenses? By non-monthly expenses I mean things like car and home repairs, birthdays, Christmas, summer vacation etc. The expenses that will come up at some point in the year but not on a monthly basis. And of course you should still include the long-term savings you need. RRSP’s, emergency funds (without employee health coverage that emergency fund could be useful when you tooth cracks… until you start paying for your own coverage) and the like. Excel has a bunch of budgets for you to download and use free of charge.
Here is a tip: Don’t guess at these numbers! Take the time to go over your last 6 months (at least) of spending and see exactly how much you really spend on Gas or Groceries. You may be surprised. If you can cut these back a little by all means do so. But don’t try to make them so tight they become unreasonably. Only you will know how much you can cut back and stick too.
Now that you know how much disposable income you need, how much do you need to earn to be able to take that cash out of your business each month? This gets a little trickier but a cash-flow projection will help figure that out. When you are starting out cash-flows can be a tricky beast. Much of it is a guessing game however with good research (check out the actual cash-flow of other companies in your chosen industry) and some serious thought it can be a pretty good “educated guess” rather than a total crapshoot! You want to run your cash-flow projections for at least 2 years. Longer is nice however your ability for foresee the next 2 years are probably better than your ability to see 5 years from now. Once you have entered your good guess numbers you will see how much income you are expecting to receive each month, what the expenses are and how much is left over for you. Remember that if you are a Sole Proprietor or Partner and you are withdrawing monies from your company, taxes are owed on that money. If you need $2,500 in part 1 ($2,500 in disposable income) tax is owning on top of that. Most of you have a couple of options. Either make an installment to your personal tax account with CRA each time you pay yourself (DO THIS) or make sure you hold enough money back to be able to pay your tax bill at tax time (DON’T DO THIS). How much you need to hand over to the Feds depends on how much you are withdrawing from your company over the course of the entire year. I’m not going to go into the details of how the income tax act calculates your personal tax return. What I will say is “all else being equal” the below table will get you somewhat close to the amounts you should be paying to CRA.
- Taxable Income $30,000 Personal Tax $3,780 Average Tax Rate 12.59%
- Taxable Income $50,000 Personal Tax $8,520 Average Tax Rate 17.04%
- Taxable Income $80,000 Personal Tax $17,550 Average Tax Rate 21.94%
Paying installments for your personal taxes is easy. You can pay online at the CRA website or through your bank’s website as a bill payment. (You have a separate bank account for your business transactions, right??) Based on our $2,500 per month scenario, you’ll be taking $30,000 out of the company over the course of the year. Looking at our rates above that means when you pull $2,500 out of your company you should also pay $315 in tax installments. Taking $6,500 per month, your additional tax installments should be $1,400. You can see how this can creep up to a large tax bill over the year and suddenly become “Ouch”. A good accountant can help you to claim all the deductions that you are entitled to but they can’t rewrite the tax code.
Also bear in mind that with these installments you are only paying tax on the monies you are withdrawing. You will still owe additional tax on any remaining profits.
Second also: When you start to earn good money and the taxes owed at the end of the year reach a certain level CRA will insist that you pay installments at least quarterly. They will let you know in advance and send you reminders when the quarterly installments are due.
Quite frankly I believe tax is a complicated beast and I always recommend having an accountant or tax specialist file your personal tax returns. I know many people who consider this a waste of money because you can file yourself however there are so many rules and regulations even I feel more comfortable having a professional review my return.
And for the last question “How long will it take to get to that level of earnings?” your cash-flow projection will show you that as well. Now that you’ve worked it out and put the numbers on paper (okay so it is the 21st century and we’re probably talking virtual paper but you get the point!) you may be surprised to see it is likely to take quite a bit longer than you thought to get the cash flowing. However now that you have a pretty good idea of how long it will take, you can start putting a little aside to supplement your earnings in the first few months or years.
If you are wanting to set up your own business anytime soon or would just like some support and feedback on your business idea, I’d love to hear from you!