Issues for small business owners to consider at the start of the year
MARTIN A. SCOTT, CFP®, EA
Happy New Year!
As we start 2024, there are financial planning items that I believe small business owners should be considering.
Cash flow
For any small business owner, cash flow is the most important item for business survival and growth. If you expect your business income and/or expenses to materially change in 2024, then now is a good time to adjust your annual spending plan appropriately. Regarding expenses, it is important to distinguish between your fixed costs (e.g., rent, utilities, salaries) vs. variable costs (e.g., marketing, advertising), which can show you expense areas (variable costs) to lower if necessary. Also, if you have existing debts, then review your debt repayment schedules, and evaluate if you have the option to refinance high-interest debts and/or consolidate loans. This type of debt management can potentially reduce your interest payments, which ultimately lowers your overall expenses. Monitoring income and expenses regularly will help you maintain a healthy cash flow and make prudent decisions about the operations of your business.
Maintaining a healthy cash flow is also important as it provides you with the flexibility to save for your long-term financial planning goals. In addition to reinvesting cash flow into your business, there are other areas to save (e.g., retirement account, college savings for your children) as well so it is a good idea to review your target savings goals for this year.
“Maintaining a healthy cash flow is also important as it provides you with the flexibility to save for your long-term financial planning goals.”
Maintaining an emergency cash reserve fund is a core element of any successful financial plan as it provides you and your business with the financial flexibility to address unforeseen expenses. If your emergency fund is not adequate or has lessened, then consider adding more money to it. If you do not have an emergency fund, then consider starting one and funding it appropriately.
Retirement planning
If you have a business retirement account (e.g., SEP IRA, solo 401k, SIMPLE IRA), then review your investment risk tolerance and investment performance of this account.
Regarding investment risk tolerance, your time horizon is a primary factor when making this determination. If you have a longer investment horizon (e.g., 20-25 years until retirement), a higher tolerance for risk may be applicable as you have more time to recover from potential losses in your investment account before needing to use it in retirement.
Regarding investment performance, an area that gets overlooked, but has a direct impact on your investment portfolio is the expense ratios (i.e., internal costs). They can be described as the operating expenses of the investment vehicles (e.g. mutual funds, exchange-traded funds, index funds) used by a financial advisor to construct your investment portfolio. Each vehicle's investment return is already net of its expense ratio. Actively managed funds generally have higher expense ratios than passively managed funds. As a financial advisor, my firm has an investment philosophy of passive management (i.e. usage of lower cost, passively managed funds such as exchange-traded funds to construct client portfolios). Regardless of your investment philosophy, it is still important to be completely informed about expense ratios because higher (unnecessary) costs can be detrimental to the success of your investment portfolio over a long-term period.
This example illustrates how higher costs could negatively impact your retirement account going forward. For illustration purposes, both options assume only having one investment fund in the portfolio, no additional contributions, and have the same average rate of return over time.
This disparity in investment value after 25 years is substantial, which is why it is important to make prudent decisions when choosing investment vehicles to use when constructing an investment portfolio for your retirement.
Life insurance and estate planning
Regarding life insurance, consider if you have a policy with enough coverage (death benefit) to protect your family and business in the event of you dying. Depending on your specific financial circumstances and goals, some reasons for having life insurance as a small business owner could include splitting up your estate equally, having an heir who would not want to run your business, and having a buy-sell agreement in place (if you have another co-owner or co-owners).
Regarding estate planning, consider updating your current plan (if necessary) to account for any new laws that impact your tax situation and/or state-specific laws that are applicable to you and your business. If you do not have an estate plan, then consider getting one set up with an attorney who will address how you would want your assets (personal and business) to be handled/distributed in the event of your incapacity or death.