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5 Financial Questions to Ask Before Starting a Business 5 Financial Questions to Ask Before Starting a Business
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5 Financial Questions to Ask Before Starting a Business

Insights & Ideas Team •  March 21, 2016 | Business and Careers

If you dream of being your own boss, you aren’t alone. In December 2015, 9.37 million Americans were self-employed, according to the U.S. Bureau of Labor Statistics. While the freedom and flexibility are tempting, there’s more to consider than just your take-home pay. Whatever your new venture may be, ask yourself these five questions about your financial situation before going solo.

1. Can I afford to start a business? You don’t want to worry about basic necessities while in the throes of starting a business. Because many startups operate at a loss for the first year or two, it may take some time to build your income back up. If you don’t have additional sources of income—such as from a spouse or another job—you’ll want a large cushion of savings to fill the gap. Borrowing from cash value life insurance policies1 or from other sources, including home equity, can also soften the blow. When deciding how much to save, consider your expenses and how long it could take to book clients and get paid.

To budget for personal expenses, prioritize the costs that won’t change, like housing, insurance, health care and child care or tuition. Then estimate flexible expenses, like food, clothing and entertainment. Compare your current spending to the bare minimum you need to get by, and land somewhere in the middle.

You don’t want your savings to completely dry up, so as soon as you can, put money toward short-term savings. Even if it’s just a small amount from each check, it will provide security. Once you’ve established your business, begin rebuilding your long-term savings.

2. What operating expenses will I need to cover? In addition to your living expenses, you’ll also be incurring the cost of running your day-to-day business. When you’re evaluating these expenses, don’t forget about these potential costs:

  • Leasing office space if your business cannot operate from home
  • Upgrading your computer, phone, internet plans, etc., to handle your work capacity
  • Purchasing software, supplies or subscriptions
  • Obtaining liability or other insurance
  • Hiring accountants, assistants or other professionals
  • Advertising, joining professional associations and attending events to help you get your name out

3. How much will I pay in taxes and fees? When you work for yourself, you must pay additional taxes, including self-employment (to cover Social Security and Medicare) and sales tax. The structure of your business (e.g., sole proprietor, limited liability company, C corporation) and your net profit or loss will impact your tax liability.

Your businesses may also need to pay to register with the state or local government or purchase a permit or license.

4. How will I handle an uneven cash flow? You likely will no longer receive a stable biweekly paycheck. Some weeks you may bring in a lot of money, and other weeks you may not make any. Are you comfortable with and able to manage this irregularity? Can you plan months, or even a year, in advance to weather the ebbs and flows of self-employment?

Changing Jobs? Top Financial Considerations Beyond SalaryOne way to help plan for this irregular income is to deposit a percentage of each check into three buckets—business checking, business savings and personal. Business checking should cover monthly expenses; business savings should cover items such as taxes, expansion plans and emergencies; and personal is your paycheck.

Determine each percentage based on your expenses and business objectives. For example, a consultant with nominal operating expenses could allocate 30 percent to business checking, 30 percent to business savings and 40 percent to personal, but someone who rents a facility or sells products may need to put more in business checking. Don’t stress about your initial allocation—you can always adjust it over time.

5. What benefits am I leaving behind? Can I fund them myself or do without them? When you go out on your own, you will need to cover or let go of a variety of employer-provided benefits that you may be accustomed to:

  • Retirement savings:  In terms of long-term savings, Simplified Employee Pension (SEP) IRAs, Savings Incentive Match Plan for Employees (SIMPLE) IRAs or Solo 401(k)s are self-employed retirement plan options. Although they offer similar tax benefits, you will lose out on employer contributions.
  • Insurance: In addition to health, dental and vision, many employers provide group life insurance at little to no cost. When you’re self-employed, it’s even more important to protect yourself and your family. Disability income insurance can help fill in the gaps if you become sick or injured. In addition to death benefits, some life insurance policies accrue cash value that can be utilized for emergencies or used as collateral for your business.
  • Paid time off: Self-employment offers a lot of flexibility, but generally speaking, if you aren’t working, you aren’t getting paid. You need a plan in place so you don’t lose business when you clock out to attend your children’s activities or take a much-needed vacation.
  • Non-monetary benefits: Do you partake in benefits such as an employee assistance program, group legal services, corporate discounts, or a company cell phone or car? If your answer is yes, budget for these, too.

Being an entrepreneur offers many great rewards and benefits but also presents many challenges. You need to plan ahead so you have the funding in place to help you succeed. Speaking with a financial professional can help you think through your options and lessen the impact on your finances. By taking the time to prepare, you may avoid some common missteps.

1Utilizing the life insurance cash values through policy loans, surrenders of dividend values or cash withdrawals will or could reduce the death benefit, necessitate greater premium outlay than anticipated and/or result in an unexpected and/or adverse taxable event.

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