Owning and operating a business can be an unbelievably rewarding endeavor. With e-commerce sites, affiliate marketing, and sales channels like Amazon, new businesses are popping up every day. The motivating factors for launching a business can vary, but whether it’s passion, sense of community, work-life balance, or financial reasons that drive us to be self-employed, we should all strive to understand some core concepts as it relates to our business and personal budgets: net cash flow to owner(s).
So, what is net cash to owner? Put simply, it’s what the owner is actually taking home from the business. It sounds like a simple concept, but a surprising percentage of self-employed individuals are unable to tell you what that figure is. It’s not as simple as looking at a w-2 wage or an income statement (though it’s a start). CPA’s and financial professionals who value the answer will probably tell you it takes a combination of tax returns and financial statements to truly arrive at this figure. A more technical definition of owner’s cash flow is the income before deducting their own compensation and benefits, discretionary (non-operating) expenses, depreciation, interest, and taxes. The intent is to arrive at the true amount of cash flow an owner has at their discretion.
So why should you care about that figure? Well, besides being an informed operator, there are a few good reasons to prioritize this information. The first, and most immediately impactful, is budgeting. Most self-employed individuals are likely taking a draw/salary or combination of the two, and it can be difficult to truly separate the business from the individual (especially for a small, lifestyle business). The goal should be to get an understanding of this figure as a means of knowing not only what the business is netting, but how much cash is actually going into your pocket. This information is a foundation for making good decisions, and for creating a personal financial plan.
Another fundamental reason to understand your net cash flow ties back to why many of us start a business to begin with: to sell it. Even lifestyle business owners find themselves with new opportunities or the desire to move on and leave the legacy to a new owner. Before reaching that point, one might consider what their business is worth. This is often looked at in estate and financial planning, as every business owner should consider a continuity plan in preparation for the worst-case scenario. While there are numerous complicated methods for valuing businesses, the conversation usually starts with profitability. Any interested buyer is going to want to know that the business will put cash back in their pocket.
So where do you start? Sound financial statements are critical. From there, it’s a matter of planning. Surround yourself with quality professionals who can help.