How to Include Your Salary in Your Financial Forecast
No matter if your business is new or old, you should make sure to follow this one simple principle: pay yourself first.
Many small business owners fail to include their paycheck in their financial forecast.
This is not a good practice because it underestimates the true costs of operating your business. (Plus, you need to survive on a livable wage.)
So, how do you include your salary in your financial forecast?
ActionCOACH’s Mark and Rick Phelps offer insight into financial forecasting, and how you can include a market-based salary in your business’s financial forecast.
What Is a Financial Forecast?
A financial forecast is a prediction that estimates future income and expenses for a business over a period of time.
It generally uses historical data from accounting and sales, economic indicators, and external market conditions to predict what will happen financially to a company in a given time frame.
“Setting a financial forecast is looking forward and giving your best guess of what could come. It’s an understanding that things can change. It looks at things like seasonality of the business you are in and the fact that markets will change,” said Mark Phelps.
Businesses should prepare a best-case-scenario forecast and a less-than-ideal-scenario forecast. This way, they can set themselves up to be in a position to make good decisions regardless of what happens.
Additionally, business owners should consider economic conditions and take precautionary measures when preparing a financial forecast.
“For example, if you were financial forecasting for 2020 and wondering ‘what can we expect,’ you’d consider that the economy has been on a boom-run for a number of years. Things have been really, really good. We can anticipate that this could continue and know that all of these runs tend to have a correction at some point, so let’s start putting away cash,” said Mark.
“At ActionCOACH, we’ve been advising our clients to stash cash. We want them to plan for the correction and be in position so that when the correction does come, they have cash on hand to pay their folks, and invest in new types of marketing so that they can acquire companies that aren’t going to last through the turmoil,” said Rick Phelps.
Financial forecasting is largely cash forecasting: cash in and cash out. Understanding your cash situation will allow you to make large capital investments in the future.
“It [financial forecasting] comes down to cash planning and evaluating cash reserves,” said Mark.
“In other words, how long can I go at the current state that I am in before I’m cash negative? And how do we work to prevent that?”
You can create a plan based on a few basic inputs, including the rate at which you’re bringing in new clients and the rate at which you’re losing clients.
“We can forecast that out and figure out if there is a financial headwind that we really need to be prepared for one way or another,” said Mark.
Plan on Multiple Horizons
Generally, financial forecasting is done annually depending on a company’s goals.
Inside ActionCOACH’s process, clients work with a coach to map out their dreams, as well as their 5-year plan, 3-year plan, and 1-year plan. The business owners then review their progress every 90-days.
Due to changes brought on by the pandemic, clients have adjusted their forecasting process to 90-day plans plus 30-day sprints.
“Our clients go through a process of analyzing their business and deciding what they want to do over the next 90 days to work on their business and to grow their business. That is our normal horizon. With so much change happening right now, we’re looking at a process that’s 90-day planning plus 30-day sprints,” said Rick.
You take the 90-day plan and put it in 30-days, and for the next 30-days you sprint to this point. And, along the way, you take advantage of opportunities.
“As much as this has been a downturn, it has also opened up many opportunities,” said Rick.
Include Your Salary in Your Financial Forecast
As mentioned earlier, an important element of forecasting that many business owners get wrong is how they pay themselves.
“We want all of our business owners to pay themselves a market-based rate – a wage that is commensurate with the work that they do in their business,” said Rick.
When the business owner is working “in” the business, it needs to be paying him or her the value of that work.
In case something happens to that owner and the game plan is for the owner to exit, the money will be available to pay for that role.
“What happens with a lot of business owners is that they run their business and just take owner draws as opposed to a salary. That can be very detrimental,” said Rick.
ActionCOACH advises business owners to pay themselves a monthly salary as opposed to taking profits out of the business opportunistically – especially if they’re having a profitable year.
“You want to save for a rainy day. You want to save for investing in the business. You want to save for hiring the next person that allows you to take another hat off,” said Rick.
“We coach business owners to pay themselves a market-based wage and then share in the profits as opposed to pulling all profits. This is an important part of forecasting.”
Open Multiple Profit Accounts
ActionCOACH also encourages business owners to have multiple profit accounts as a way to invest in their businesses.
The first account should include a minimum 10% net profit.
“Every business needs to make a 10% net profit. If your business is not turning a net profit of 10%, you’re not going to make it in the long term. You need that money to be able to reinvest in your business,” said Rick.
A net profit between 10% and 20% should be placed into a separate savings account in case you have days, months, or quarters where you don’t make a 10% net profit. You’ll want to pull from this account.
And a third profit account should be opened for net profits over 20%. This savings account should be used for longer-term investments and if you want or need to draw from the business.
While you can’t predict the future, a financial forecast helps you track your cash and provides a vision for where your company is heading. By including a market-based salary in your forecast, you’re painting a realistic snapshot of the viability of your business and you’re learning to live on what your business can afford to pay you.