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NH - Blogpost-June 30, 2020Blog Feature

When you look at the money your business has earned over the course of a month, how do you decide where to spend it?

You probably start by paying off your monthly expenses, move on to chipping away at debt, and hope there’s something left for you in the end. Even then, you might be tempted to spend that leftover cash on something you’ve been needing to buy — like a new software subscription or tickets to an upcoming conference.

A smarter money management strategy would be to pay yourself first.

I realize that may seem counter intuitive since a personal salary doesn’t keep the office rent paid or your website online. But if you make this shift and prioritize storing away your earnings before you pay your bills each month, your financial stability will actually improve.

Let me show you how.

How to Pay Yourself First

This finance management strategy is going to look similar to what you’re probably doing now. The key difference is the order in which you do these steps.

Step 1: Know Your Numbers

Before you do anything else, you need to know:

  1. How much money you earn each month.
  2. How much money you spend each month.

In the beginning, it might be difficult to estimate your earnings if the influx in business isn’t quite predictable or even yet. But that’s okay. Pick a good average to work with.

If your spending varies, however, there’s something wrong. Your expenses should not change much from month to month. If they do, rework and stabilize your budget before you do anything else.

Step 2: Decide How Much Money You’re Going to Pay Yourself

Next, use this formula:

Monthly Earnings – Estimated Monthly Taxes – Monthly Expenses = Profit Margin

This formula will help you determine how much of a profit margin you realistically have to work with each month.

Let’s say these are your actual numbers:

$10,000 – $2,500 – $2,500 = $5,000

So long as you’re confident in your monthly income, it would be safe to assume that you’d have roughly $5,000 to pay yourself as a salary each month. It’s okay to start with a smaller amount, too, especially if you’re looking to scale your business soon and you know your expenses are about to grow with the addition of employees and enterprise software subscriptions.

Whatever you do, pick a consistent amount to pay yourself each month and commit to it.

Step 3: Set Your Savings Goals

Your personal salary is not to go towards the paying of taxes and other business expenses. These are your earnings to be spent on things outside of the business. That said, this isn’t monopoly money that you should be using to buy all the things you need and want for your life.

You still need a plan.

A good rule of thumb is to divvy up your personal savings as follows:

  • 50% to things you need (like household expenses, an emergency root canal, new clothes for the kids’ school year).
  • 30% to things you want (like a trip to Hawaii in the fall, new tires for your car, an addition on your home).
  • 20% to your retirement savings, investments, and debt repayment (if you have any).

So, let’s say you’ve decided to pay yourself $3,000 every month. You’d end up with:

  • ● $1,500 for necessities.
  • $900 for desirables.
  • $600 for long-term savings.

What’s nice about allocating so much to things you need is that you might not spend that much on them every month. That way, if an emergency arises, you won’t have to worry about where that money will come from or figure out which credit card to put the debt on. You’ll already have the money set aside to cover it.

Which brings me to my next point…

Step 4: Automate Your Payments

It’s one thing to commit to paying yourself a certain amount every month. It’s another thing to fully commit to the goal and do it.

The best way to ensure this happens is to automate your payments for the 1st of the month. This way, there won’t be any temptation to buy things you need or want for your business before you’ve had a chance to set aside money for yourself.

In addition to automating these payments, you should create dedicated accounts for them, too.

  • Put your “needs” and “wants” money into high-yield savings accounts.
  • Put your retirement funds into a tax-advantaged retirement account (or a super [link to post], if you’re in Australia).

By creating these systems, you’ll protect your salary from pillaging.

Step 5: Monitor the Data

While you’re working on growing your business, pay close attention to your cash flow. If you find that what you’re setting aside for yourself is cutting too deeply, then you may need to make adjustments. Cutting costs will help as will charging more for your services, though you still might need to reduce your salary payments until you’re feeling more confident in your cash flow.

Once you’re on a roll though and profits are consistently high, you can increase your salary payments once more. And keep doing so as your business grows!

The Benefits of Prioritizing Your Personal Profit

As you can see, there’s nothing too outlandish about this process. It’s all of the things you should be doing to manage your money anyway, only it gives priority to paying yourself first.

There are a number of reasons to embrace this money management method:

  • It creates a clear divide between business and personal spending.
  • It provides a safety net for those unexpected emergencies.
  • It gets you in the habit of carefully thinking through where your money goes, in the short and long term.
  • It curbs impulse buying and, consequently, debt accumulation.
  • It enables you to see how your business helps you live the life you want, which, in turn, will inspire you to make better decisions for it.

Best of all? You won’t need to stress over money anymore. If you use this system, you can stop worrying about how you’re going to pay your bills or where you’re going to get money for the vacation your family wants to go on. You’ve already planned for it all.

If you’d like some help running through this exercise, we’ve put together a Pay Yourself First Worksheet. Click below to download your free copy and get started on planning your way to financial freedom.

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