Beyond the Business: Financial Planning Considerations for Small Business Owners

Owning a small business is both a professional commitment and a major personal financial decision; representing a significant source of income, a large portion of a business owner’s net worth, and years of hard work. It may also represent independence, flexibility, personal achievement, and legacy.

With so much tied to the success of the business, financial planning for an owner requires a broader perspective. The question isn't simply, “How is my business doing?” It is also, “Is my business helping me achieve the financial life I want?”

At Comprehensive Wealth Management, we believe effective planning begins by looking at the business and the owner's personal finances as interconnected parts of one larger financial picture.

Create a Clear Separation Between Business and Personal Finances

While the business and the owner’s personal finances are interconnected, one of the fundamental principles of effective business and personal financial planning is maintaining a clear distinction between the two.

Business owners should have appropriate practices in place for separating business and personal expenses while maintaining accurate financial records. It is also important to establish a consistent approach to owner compensation. These practices can provide greater clarity around the true financial health of the business while making personal budgeting and retirement planning easier.

Owner compensation needs to be a thought-out plan. Rather than treating the business bank account as an extension of a personal checking account, it is helpful to establish a deliberate strategy for salary, distributions, or draws based on the business structure, cash-flow needs, and personal financial objectives. The goal is to create a plan in which the business supports the owner's financial plan without compromising the company's ability to operate and grow.

Focus on Cash Flow, Not Just Revenue

Revenue is an important measure of business activity, but it doesn't necessarily tell the whole story. Profitable businesses can still experience cash-flow challenges. Payroll, taxes, debt payments, capital expenditures, and other obligations can place significant demands on available cash.

We encourage business owners to understand not only their income statement, but also the timing and sustainability of their cash flow. Just like in personal budgeting, maintaining an appropriate business cash reserve can provide flexibility when revenue fluctuates or unexpected expenses arise.

The right amount of liquidity will vary by industry and individual circumstances. A seasonal business, for example, may have very different cash needs than a professional services firm with recurring revenue.

Tax Planning is an Ongoing Strategy

Tax planning is most effective when it is proactive rather than reactive.

Depending on the business structure and the owner's circumstances, tax considerations may include estimated payments, payroll taxes, self-employment taxes, state taxes, retirement-plan contributions, and eventually the (hopefully large) tax consequences of selling or transferring the business.

Rather than waiting until tax season to review these issues, business owners should consider working throughout the year with their CPA and their financial advisor. A coordinated approach can help ensure that decisions made are evaluated within the context of the larger financial plan.

The objective isn't necessarily to minimize taxes at every opportunity. Sometimes a decision that creates more taxes today may bring a stronger long-term financial outcome. Good tax planning considers both the current year and the future.

Don't Let the Business Be Your Only Retirement Plan

For many business owners, the business is their largest asset. That often leads to retirement account contributions taking a back seat to reinvesting in the company. However, relying exclusively on a future business sale to fund retirement can introduce significant uncertainty to a business owner’s retirement plan.

Business owners should consider building personal retirement assets alongside the value being accumulated in the company. Depending on the circumstances, potential strategies may include IRAs, SEP IRAs, SIMPLE IRAs, 401(k) plans, or other qualified retirement plans. At CWM, we help business owners decide which is the appropriate strategy based on their individual circumstances.

The broader objective is diversification. Building assets outside the business can gradually reduce the owner's dependence on a single source of wealth.

Protect the Business

Building a successful business requires years of effort. Protecting that business should be an equally thought-out part of the planning process.

Consider what could happen if an owner became disabled or seriously ill and could no longer work. What would happen if a key employee left? What if an unexpected liability, property loss, or other event disrupted the business operations? Is your business set up in the right structure (Sole Proprietor, LLC, Corporation, etc.)?

Risk-management planning can help address these possibilities. Depending on the circumstances, this may involve evaluating business liability coverage, disability insurance, life insurance, key-person insurance, or other forms of protection.

Business owners should also review their personal estate plan documents and beneficiary designations periodically. Personal and business interests can become complicated when ownership, family relationships, and estate planning come together.

The purpose of the planning isn't to predict what will go wrong. It is to make sure that an unexpected event doesn't undo the financial security the owner has worked so hard to create.

Know What the Business Is Worth

For many owners, the business is their most valuable asset. However, its value may not be fully understood until the owner begins considering a sale or succession plan. We encourage business owners to think about this well before an exit becomes imminent.

What would happen to the company if the owner stepped away? Are financial statements accurate and well organized? Is there a capable management team?

These factors can influence not only the sustainability of the business but also the potential value.

Consider the Risk of Concentrated Wealth in the Business

A successful business can create substantial wealth, but it can also create concentration risk.

An owner may have a significant percentage of their net worth tied to the same company that provides their income. If the business encounters financial difficulty, both cash flow and net worth could be affected at the same time. This is why diversification outside the business can become increasingly important as wealth grows.

Over time, an owner's financial strategy should involve systematically moving some wealth from the business into personally held, diversified assets. The appropriate balance will depend on the owner's goals, risk tolerance, liquidity needs, and expectations for the future of the business.

The goal here is to ensure that the owner's entire financial future isn't dependent solely on the business’s continued success.

Define What Success Looks Like Beyond the Business

Perhaps the most important part of financial planning for a business owner has little to do with the business itself. It’s defining what success looks like to you- what we call Living Richly.

For some owners, the goal is to retire early. For others, it may mean working fewer hours, traveling more, supporting family members, or purchasing additional businesses.

Identifying and defining these goals can influence today's decisions about spending, saving, investing, borrowing, and reinvesting in the business.

A comprehensive financial plan provides a framework for connecting all decisions. It helps answer not only if the business is successful, but whether that success is translating into the personal and financial outcomes the owner ultimately wants.

Turning Business Success Into Personal Financial Security

Small business ownership offers tremendous opportunity, but it also comes with unique financial responsibilities and risks. Because the business and the owner's personal finances are so closely connected, planning should consider both sides of the equation.

Cash flow, taxes, retirement savings, insurance, investments, estate planning, business valuation, and succession planning shouldn't be viewed as isolated topics. They are all pieces of a larger strategy.

*******

At Comprehensive Wealth Management, we believe the role of financial planning is to help business owners make those connections. By coordinating business decisions with personal financial goals, owners can work toward transforming the value they've created into lasting financial security.

Your business may be one of your greatest accomplishments. With thoughtful planning, it can also become an important vehicle for achieving the life you envision beyond the business. If you’re a business owner and would like our team of accredited and tenured advisors to review your situation, contact us at (425) 778-6160 to schedule a meeting!

Comprehensive Wealth Management, LLC (CWM) is an SEC registered Investment Advisor and Pacific Northwest wealth management firm that partners with clients to articulate and help achieve their financial goals as prudently as possible. Our high-touch, client-focused investment planning and implementation are designed to make us a trusted resource for executives, business owners, and other thoughtful investors seeking to strengthen their financial health holistically and intentionally, while managing risk while pursuing long-term growth.

All investments involve the risk of potential investment losses as well as the potential for investment gains. Past performance is no guarantee of future results. This communication is informational only and is not a solicitation for investment advice.

Comprehensive Wealth Management, LLC (CWM) does not offer tax advice. Please consult your CPA for specific tax questions.