Maybe you’ve subscribed to PFPro for years; maybe you’ve gotten yourself out of debt, established an effective budget, bought a new home and accomplished other serious PF feats. However, it doesn’t matter how amazing you are at managing your own finances – you probably still aren’t ready to start your own business.
Personal finance and business finance might share a word, but that’s almost where the similarities stop. If you need convincing that you aren’t a business finance pro despite your expertise in personal finance, here’s a guide to the differences between maintaining your finances and juggling money for a business. Further, once you are finally convinced, you should consider enrolling in an MBA program online to shore up your BF skills.
In personal finance, you use diligence and prudence to increase your wealth; in business, you use leverage. Leverage is by far the most significant difference between personal and business finance. It is the process of multiplying gains, most often by borrowing money.
At some point, every business engages in leverage. It allows entrepreneurs to establish the business and find success with a lower investment, and it means the ratio between their investment and their profits is much larger. Here’s an example:
You borrow $10,000 from the SBA to build a business, and you invest $10,000 of your own money into your venture, as well. Within a few years, your business does well, and you turn net profits of $7,000. As a result, you have a healthy $24,000 in your business coffers, so you can return then $10,000 of the loan (ignoring interest, for the sake of example expediency) and retain your 70 percent growth.
Admittedly, it is possible to use leverage in personal finance – it is just severely frowned upon. For most people, leverage is too dangerous a financial practice to apply to personal assets. If leverage fails for your business, you can continue living your life; your business might fold, but you will maintain your home, car and personal savings. However, if leverage fails for your personal wealth, you lose everything. Thus, you should truly only apply leverage in BF and ignore the concept entirely in PF.
If you are serious about personal finance, you might have a personal cash flow statement that measures your inflows and outflows so you can build a better budget. You need a similar document for your business, but it needs to be dramatically more accurate and detailed. Cash flow problems are the number-one cause of business failure; your business might be booming, but if your cash flow isn’t balanced just right, it will crash and burn. Here’s another example:
Your business wins a bid for a project that will produce $50,000 in revenue, split into two payments of $25,000. At the start of the contract, you send an invoice for the first payment, due in 30 days, and one month later, at the conclusion of the project, you send out the invoice for the second payment. Assuming you receive the money – which is never a given – you won’t have any cash in hand until at least 30 days from the start of the project, and you won’t have the full sum until about two months later. Thus, you need to find a way to continue paying your business expenses until those payments come in.
Paradoxically, growth costs businesses substantial amounts of money, which means the hardest, leanest years are usually the ones when your venture is growing the fastest. In PF, you always want a positive cash flow, but in business, that isn’t necessarily true, which can be especially confusing to PF pros. Cash flow is an exceedingly delicate issue that requires years of practice, which is why it is useful for wannabe entrepreneurs to study BF in business school before launching their startups.
Revenues and profits, assets and liabilities – these seemingly familiar financial terms function radically differently in the realm of business finance than they do in personal finance. As a result, it is critical that you avoid mingling your personal finances and your business finances after you launch your venture. Doing so increases the risks of every BF or PF decision, imperiling both business and personal wealth at once. Still, you shouldn’t neglect your PF practices after you become an entrepreneur. After all, becoming personally wealthy was likely a major driver of starting your own business.