Running a business requires more than just passion and hard work—it requires a clear understanding of your financial needs and goals. A crucial question to ask yourself is: Can your business support your personal financial needs and wants, and do these numbers excite you?
Here’s how you can determine that, following the Profit First principles.
Step 1: Calculate Your Annual Need
Start by identifying your monthly financial need, which includes all your personal expenses such as housing, utilities, food, and other necessities. Once you have this monthly figure, multiply it by twelve to get your annual need. This is the net amount you Need to pay yourself each year to cover your basic expenses.
Step 2: Determine Your Want Number
Next, calculate your Want number. To find your Want number, take your Need number and multiply it by at least two. This number should excite you. If doubling your Need number doesn't excite you or align with your desired lifestyle, consider multiplying it by three or even four. The goal is to have a Want number that truly motivates and excites you, representing the lifestyle you aspire to achieve.
Step 3: Determine Your Pay Percentage
Knowing your annual Need and Want numbers allows you to set realistic financial goals for your business. Next, you need to determine what percentage of your business's revenue should go toward paying yourself. According to Profit First principles, a healthy percentage might range from 20% to 55%, depending on your business's Real Revenue.
Real Revenue is calculated by subtracting the costs of goods sold (COGS) and any subcontractor expenses from your total revenue. This gives you a clearer picture of the actual earnings that your business generates.
For instance:
- If your business generates up to $250,000 in annual Real Revenue, aiming to pay yourself around 55% of that revenue can be a reasonable target. This ensures you cover your Needs and Wants while leaving enough funds in the business for taxes and operational costs.
- If your business generates between $500,000 and $1,000,000 in Real Revenue, you might aim to pay yourself 35%, which may align closer to your financial Wants and not just Needs.
Not sure how to calculate your real revenue? Reach out to your accountant, or contact us and we’ll help you figure it out.
Step 4: Set Business Revenue Goals
With your target pay percentage in mind, you can now set specific revenue goals for your business. Determine the total revenue your business needs to generate annually to meet your pay percentage target. This approach allows you to plan and strategize effectively, ensuring your business operations align with your financial needs.
Step 6: Plan Your Business Activities
To meet your revenue goals, break down your business activities and identify the number of sales, projects, or contracts you need to secure. For example, if you run a consultancy and have an average project value, determine how many projects you need to complete in a year to achieve your revenue target. This calculation helps you create a clear action plan, making your financial goals tangible and achievable.
Putting It All Together
Understanding your financial needs and setting realistic business goals are crucial steps to ensuring your business can support you. By calculating your annual needs and determining a healthy pay percentage, you can align your business activities with your personal financial goals. This strategic approach helps you move from simply managing day-to-day operations to building a sustainable and profitable business.
By following these steps, you too can unlock the power of knowing your financial needs and creating a business that truly supports you. This ensures not only your business's success but also your personal financial freedom and satisfaction.
Tags:
- Business Finance
- Profit First Principles
- Financial Planning
- Entrepreneurial Success
- Real Revenue Calculation