Just like we already know, a sole proprietorship has a single owner and the primary goal of this owner will always be to grow the value of the capital invested in the business which is also called Equity. Note that the key objective of maximization includes the maximization of net income given the current resources of the business. Since sole proprietorship has only one owner, there is no need to decrease long – term debt to reduce the risk to the owner.
The purpose of a sole proprietor is to earn more income and he will have to pay more taxes so the goal is not to minimize the tax impact on the proprietor. Similarly, the goal is also not to minimize the reliance on fixed costs, but simply to maximize the market value of the equity.
What is the Primary Goal of Financial Management for a Sole Proprietorship?
The financial goals for sole proprietorships may vary based on whether the owner is primarily looking to make money or whether financial success is a secondary priority. But irrespective of these differences, financial management for a sole proprietorship mainly aims to separate business and personal finances to obtain clear financial statements and increase the value of the business.
In a sole proprietorship, separating business and personal finances is the bed rock of Financial Management. Although the owner is not legally required to open a separate bank account for the business, but having a business bank account helps a sole proprietor to more accurately track and allocate business and personal expenses.
For any sole proprietorship, financial management is expected to be channelled toward separating business and personal income and expenses – at least on paper – so that the owner can understand patterns and also file an accurate tax return.
In this type of business formation, any efforts to ensure that business activities stay separate from personal financial activities will pay back handsomely at tax time. Even though the business earnings are part of the owner’s personal earnings, they are expected to be recorded separately and documented as a legitimate enterprise, with a clear revenue stream and records of deductible business expenses.
An important goal of sole proprietorship financial management for tax purposes is to document and organize information about company transactions to facilitate the process of filling out tax forms. Most of a sole proprietorship’s operating expenses are tax deductible, meaning these sums can be used to offset incoming revenue amounts to calculate profit and taxable earnings.
However, always note that business and personal expenses sometimes blur, especially if the business is managed from a home office or you own a business, such as a food company, where it is tempting to use business inventory to meet personal needs.
A good financial manager should aim at eradicating blurry lines between business and financial expenses and also noting all expenditures in the appropriate category. Also good financial management comes into play when a sole proprietor decides to sell the sole proprietorship. At this point the financial records will provide an indispensable record that a prospective owner can use to analyze the business financial success.
As a sole proprietor, it is very pertinent you understand that thorough records and organizing these records clearly and logically will make it easier to disclose the information that a prospective buyer needs. Even your financial and clerical diligence will also speak well of your managerial skills and your ability to implement systems that a new owner can take over without difficulty.
Top Financial Management Tips for Sole Proprietors
A sole proprietor runs a business by themselves. They are legally responsible for all aspects of their business and have complete control over everything. Howbeit, as a Sole Proprietor, it is important to manage finances especially since it is the foundation of the business. Below are some tips on how to you can make the most of your hard – earned dollars.
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Manage Cash Flow
First and foremost, you have to understand that cash flow is the total amount of money going in and out of a business. As a sole proprietor, cash flow can vary a lot of the time and staying on top of your cash flow can be difficult when the flow fluctuates. However, it is quite pertinent to have some form of cash flow management. Sole proprietors are advised to always stay on top of their records by updating them at least once every week.
Note that by doing so regularly, you’re able to see your business cash flow at any time. You can have a first – hand insight on where your profits have decreased, and can attribute when and where that occurred. Another method is for sole proprietors to have a separate account for their business profits which pays them a set wage at a certain time every month. This account will be separate from the sole proprietors’ personal everyday account.
Business forecasting is more or less the same as predicting your future business developments. Note that this concept is based on your past and current business activity from your financial statements. Business forecasting offers a business owner a realistic idea of where the business is headed in the future in order to form business plans.
Forecasting also lets a business owner understand potential future problems, and fix them before they become a reality. Have it in mind that when you first start your business, it is critical that you complete monthly or weekly forecasting. And as the business becomes more established, you can then switch to making these forecasts annually.
Sole proprietor Insurance
Since a sole proprietor is tasked with everything concerning the business, they will have unlimited liability. In a scenario where a sole proprietors company goes into debt and they cannot pay it back, the personal assets of the owners will be used to repay this debt. However, note that insurances a sole proprietor will acquire will depend on the type of business they are running. For instance, in a track business, the business will need personal injury insurance.
Nonetheless, all sole proprietors should have income protection insurance. Sole proprietors more or less work for themselves and profit is generated by the business when they work. If they can’t work, it means no profit will come in. Howbeit, income protection insurance is very necessary for them as it pays benefits to the sole proprietor when they cannot work for some reason e.g. illness.
Know your business numbers
Many sole proprietorship businesses have found themselves with no cash buffers in their business and personal accounts. They might have been driving blindfolded, not aware of their business profitability or the level of debts racking up. Note that being able to understand the profitability, assets and liabilities of your business in real time means that you will hit those road humps a lot less frequently.
Bookkeeping and Invoices
Have it in mind that as the financial transactions of your proprietor business become more plentiful, a form of bookkeeping becomes a greater necessity. You can hire someone to handle the books, or you can use an available bookkeeping software system and handle your own data entry.
A method to generate professional invoices is necessary if your business provides services or products for which you get paid at a later date. An invoicing system helps keep track of who owes you money and how much.
Always pay yourself first
Starting and managing a small business can be daunting and there’s a chance to take what is left at the end of the week. Or maybe you might choose to take a standard amount of money willy – nilly, irrespective of whether the business has made that much money. And that’s when the ATO and credit card debts start to blow out.
Always remember that your personal bills don’t reduce if your business’s profit reduces. Take your time to prepare your personal budget and determine an amount you need to generate from your business with a little buffer added.
So, guided by your numbers and your targets, if your profit is reducing and it is likely that there won’t be enough money to make that weekly amount you need, you could put some of those contingency plans in place. Chase outstanding debtors. Finish off that job and invoice a few days ahead of schedule. Review your job costs and compare your quote. Review your overheads. Revise your hourly rate.
Sole proprietor Tax
It is very necessary that sole proprietors understand their tax obligations. Sole proprietors tend to be taxed as individual taxpayers. In a sole proprietor’s individual tax return, they are expected to report their business income. If you are likely to make more than $75,000 annually, you should be registered for Goods and Services Tax (GST).
In the United States, the current tax – free threshold for sole proprietors is $18,200, meaning that if they make below this amount annually, they don’t have to pay tax on this income. Also remember that sole proprietors have no separate business tax return, but can claim deductions in some circumstances.
These business owners can claim superannuation contributions, so long as it is recognised by their fund. At the end of the financial year, the funds put into a sole proprietor’s personal super will be deducted from their income, meaning that they can potentially pay less income tax.
Be proactive with spare dollars
As a sole proprietor, you may strategically decide to not to contribute into superannuation like we stated above, but instead put those funds into your mortgage and pay down your non – deductible debt as quickly as possible. Indeed, there is another twist that could get you ahead even quicker and ensure you have money to pay the tax man at BAS and tax time.
Businesses managed via a trust often have a separate business bank account to set aside their GST, PAYG and SG each week. As a sole proprietor, you could set these monies and any other spare dollars aside in an offset account against your home loan or business loan instead of actually making additional capital repayments.
According to experts, this strategy will reduce your interest bill and will ensure you have the funds to pay the ATO when the time comes. Interest rates are low at the moment, but it is a saving nonetheless. The offset account also has an advantage over dumping funds straight into your loan as redraw fees may apply.
Create wealth outside of your sole proprietor business and plan for the future
Anyone who starts and manages a sole proprietorship has indeed taken a considerable risk. And always deserve to be rewarded well for that risk. Most business owners believe that their retirement settlement is in fact the business they are building. But we’ve seen during COVID – 19, businesses that were successfully operated for generations were wiped out overnight and some have even been left with debts.
So if you have an excellent support team in your accountant, solicitor and financial planner, have a meeting now and start hatching your roadmap to secure your financial future and protect your assets. A lot of small business owners in the United States setup their own Self – Managed Super Fund (SMSF) with a view of acquiring a commercial property to operate their business from instead of paying rent to someone else. This is one of the strategies many sole proprietor leverage to create wealth outside their business.
The primary goal of financial management for a sole proprietorship is indeed to maximise the market value of the equity. However, just like it was stated above, a sole proprietor can run their business using their Social Security number as a tax ID number and handle all cash flow transaction through a personal checking account.
But for accounting and tax purposes, though, it might be much advisable to keep all business money transactions separate from personal money matters. Because the proprietorship is a business, and all the money should be treated as a business would.