Pay Yourself First

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The single hardest part of any business, big or small, new or old, has got to be how much to charge for your services. Too high, and you don’t win the job. Too low and you don’t last the year. You’ve got to be competitive as a new entity yet keep cash flow high enough that you can pay your overhead and afford yourself some much needed growth. For me, growth comes in hiring people and buying tools that make my job easier while allowing for more complex designs.

Even if you’ve figured out the magic formula that balances all of those variables and you are running steadily in the black, you’ve now got to start thinking about the benefits that you lost when you left your corporate job and started entrepreneurship. Most notable of those, especially for me, is the loss of a formal retirement plan. Paying for that type of benefit is fully up to you, the business owner. You don’t have to, choosing instead to keep your cash in the business or even just use it to make ends meet.

That’s when all of these financial gurus decided to coin the term “pay yourself first”. It’s a great idea, especially in theory. You need to save for the future, especially if your fledgling business isn’t a cash cow or likely subject for a multi-million dollar buyout by Asian investors (not applicable to furniture builders).

As a risk taking entrepreneur, the thought of saving money and/or making money is appealing and you’re probably perking up right now. Pay myself? Money, for me? Well, yes. The most literal sense of that phrase is to set aside (hopefully using auto-draft) money for retirement before you pay suppliers, bills, rent – anything. This guarantees your future, especially since most bills have some kind of net 30 payment terms anyways (you shouldn’t use that, by the way).

How to do it

It should be no surprise to you that I have an interesting twist on this little financial anecdote. Here’s why:

When I submitted my first few proposals I essentially figured the cost of materials and a few hard money line items like a truck rental and delivery fees and then I just added as much money as I thought the client would let me get away with. A popular way to bid work is to double the material costs and then add in a small percentage. People say that at least guarantees that you won’t lose money. This is true – you won’t lose money and your checks won’t bounce, but you’re left with a pot of money that doesn’t reflect the time spent or thought to paying yourself first, a la retirement savings. Without a lot of experience it’s pretty tough to formulate a bid any other way. You don’t know how long things take, nor can you anticipate all of the ancillary costs that creep up.

Lately, I pay myself first by estimating the work required for the proposed job and paying myself a fair wage for doing that work. Added to material costs and overhead is profit, resulting in a net proposed price. This way, I ensure that I can earn a basic living with adjustments made to gross profit margins. This model, while sounding simple, is a bit challenging to get the hang of. Not so surprisingly, it’s how proposals work for at least the good companies (I’ve worked for some where we just guessed). This line of thinking makes a lot of sense to me and really helps my bids to be competitive. I may have a decent amount of experience and used to charge close to $300/hr for engineering work but some days I’m a welder whose average shop rate is roughly $25/hr for GMAW work.

You can’t be a competitive welder at $300/hr. I’m sorry, it just won’t work out. My trick is to break my work into three categories: design, welding and woodworking. I then estimate how long I’ll spend in wearing which hat and apply my hourly rate to the proposal price. You then get a base price that you add profit to. It’s much easier to negotiate your price (read “lower”) when you are just dealing with seeing your estimated profit change. You are still guaranteed that you will make a reasonable wage doing a reasonable task. Even better, you know you can hire a contractor to help you while you work on the next project. Pay yourself first. That money is then used to pay your bills, leaving profits for business and personal growth, just like you always wanted out of being your own boss.

 

In other news – I’ve just started using an online accounting platform called Wave. It’s made for small businesses and uses a pretty neat business model. More to come as I get more time behind the wheel.

In even more news, and as a follow-up to this post, I’m meeting with my banker to discuss creating a retirement plan for myself. It’s looking like small business plans are very, very favorable and might be something to consider.

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