Have you ever wondered if there’s a magic number for how much you should be spending on your small online business?
When we’re just getting started, we excitedly start buying everything we think we should in the name of “investing” in our dreams, right? But even the solopreneur-honeymooners have to acknowledge that there’s a point where it all levels out. When you get into a routine with your business, and you start to turn those “investments” into profit.
But, unfortunately, many (too many) small business owners will never be able to level out. They’ll run their business into the ground before it ever got a chance to take off.
So, today’s the day. I’m going to tell you the magic number for your business expenses. Sound too good to be true? Stick around, you non-believer. We’ve got work to do!
As with most of the posts I write, we have to interrupt the regularly scheduled content with a bit of a “Let’s Get Our Facts Straight” segment.
- Why does all this matter?
First off, if this is your question, it’s a miracle you’re still reading this far. So I want to applaud you! You’ve taken a major step in considering the financial health of your business. Knowing how much you are spending and should be spending on expenses for your business is paramount to your ability to start turning a profit.
Unfortunately, checking your bank balance is not enough to go off of to assess your business’ finances. You’ve got to know more.
- You need to know if you’re a startup.
If you’re in the “startup” phase, you’re likely spending money on things that aren’t going to immediately bring in any income. For example, paying for web hosting to set up your first website. It’s very likely that it’ll take you a few months after creating your website to generate enough traffic to start making your first sales (this applies for affiliate, digital product, services, ads, and other types of "income” activities).
If this is you, it’s critical that you control yourself during your “honeymoon” phase. If you don’t have to pay for it, don’t pay for it. I recommend investing in a good website that you own, yes. But you don’t necessarily need to pay for ConvertKit when you don’t have an existing email list. MailerLite’s free plan should be plenty! Similarly, you can use Wave’s free accounting software versus Quickbooks. Be smart about it!
But also, know when you’re no longer a startup. Your foundation is in place, your income streams are prepared. If you’re making money relatively consistently (you can bring in something monthly), you’re out of the startup phase. If you should be making money consistently (all the pieces are in place, you just need the sales), you’re out of the startup phase.
- What does being a startup have to do with this?
Great question. The magic number I have for you today is a percentage of your income. So if you’re not expected to have income yet, you’re not quite ready for this (but stick around! You’ll want to target this number ASAP). But if you can’t justify being in this early stage anymore, it’s time to put on your fancy pants and treat this gig like the Business it is. With a capital B.
The Magic Number for Your Small Business Expenses
Are you ready for it? There’s no catch.
Your expenses should be limited to 30% of your total revenue.
The end, have a nice day. See you next week.
Oh, wait - you want to know why? Aw, gee, I guess I’ll tell ya.
Where The Magic Number Comes From
This is where I have to step out of the spotlight and give credit where it’s due. 30% is not my number. In fact, as of this writing, I’m currently way above this number, so I’ve got work to do myself.
This percentage comes from business finance expert Mike Michalowicz’s Profit First system. (Are you a reader? I definitely recommend the book!)
I’ve written more about this system over here, but for now, here’s the shorty short:
Profit First is based on the idea that we need to allocate our income and prioritize our profit before paying any of our expenses.
Typically, we take our income, subtract our expenses, and call the leftover profit (if we’re lucky enough to have any).
Mike suggests we flip the script. We take our income, prioritize a percentage for profit, and take whatever’s left and use that to pay our expenses. If there’s not enough, we have too many expenses and need to make cuts. His system guarantees profit.
And, because his recommended allocations include other accounts, his system also guarantees tax savings and a paycheck for YOU. Not bad, right?
He has various recommended percentages for various sized businesses, but those of us in the smaller blogging, digital products, and service-based business spaces all likely fall in the <$250k in Annual Revenue category.
With this in mind, his recommended percentage to be allocated to Operating Expenses is 30%. Many of us are going to be over that, when we take a look at our own Profit & Loss Statements. That’s okay! Get started today with where you’re at, and work your way towards it.
Related Post: Mastering Your Blog’s First DIY Income Statement
It’s also worth noting that Mike recommends keeping separate bank accounts for each category (Income, Tax, Profit, Operating Expenses, and Owner’s Compensation). It’s essentially the logic of the envelope system for personal finances!
Do Your Expenses Follow the Magic Number?
So when you total up your regular expenses (don’t forget to factor in those quarterly and annual expenses! I’d probably average them out over time as a rough baseline) and your total GROSS revenue, you should be able to determine your current percentage. Just divide the expenses by the income number and multiply by 100!
Example: Let’s say you made an average of $1,000 a month over the last several months. Additionally, you average $685 in monthly expenses for that same time frame (factoring in annual renewals and investments in courses and coaching). 685 / 1000 = 0.685 x 100 = 68.5%
You’d need to work on increasing your income and cutting your spending down to just the necessities until you can fit into the 30% mark! Otherwise, you’re robbing your business (profit), yourself (owner’s compensation) and the government (tax)!!
How To Use the Magic Number to Make Decisions
Here’s another thought! What about when you’re considering a new monthly expense?
If you follow the Profit First system completely, you’ll have an Operating Expense bank account that will tell you the exact amount of cash you have on hand that’s available for spending. If you keep a budget similar to the one I recommend in the post linked below, you should know how much of that is already tied up in regular subscription-type obligations.
Related Post: How to Create & Follow a Monthly Budget for Your Blog
(This related post is written with “Startup” phase businesses in mind, but it still works for creating plans for your Operating Expense account!)
But what about a longer-term expense? For this example, let’s say you’re considering hiring a bookkeeper to handle your monthly account reconciliations and financial statements.
Considering the business sizes I typically work with, I’d quote roughly $175-250 for a monthly bookkeeping client (if you’re curious, I only offer bookkeeping services to coaching clients - you can become one here!). We’ll say $200 for this example.
If you earn at least a consistent $2,500 a month, your 30% threshold is $750.
So if adding $200 a month to your current expenses will put you over that amount, you really can’t afford a bookkeeper yet (even though it feels like you would since you’re earning over 12 times that!).
See how this number can be a game-changer for your business?
Are You Curious About Profit First?
If you’re like I was and you’re coming across this concept for the first time, it might just be blowing your mind.
So first off, I definitely recommend reading the book. Mike Michalowicz is hilarious, and makes reading about business finance a lot of fun.
But the book is also written with a larger range of small business owners in mind. You could be earning anywhere from $0 a year to $25 million a year, and you’d still be included in this book (25 mill is small business? Apparently!).
If you don’t have time for a whole book, I’ve written an introduction to the system for you. Head on over here to read it: An Intro to the Profit First System for Solopreneurs!
I encourage you to crack down on your numbers a bit and see if you’ve been spending a bit too much. It might be time to slow down on the “investing” and focus instead on streamlining your business and growing your sales!
Until next time!
- Katie Scott