Money Health: Taxes and Finance
Oftentimes, people ask me what Tax Hack does. Is it taxes, accounting, advice, or all of those?
My answer is simple. At Tax Hack, our mission is to deliver the best finance and tax consultant anyone can ask for: themselves.
I’m not being trite. The truth is, we do a lot for our clients. And nothing excites us more than helping clients fight the IRS, catch up on taxes, or organize receipts into beautiful, digital accounting dashboards. But focusing on what we do day-to-day misses the bigger picture of how our clients’ skillset and mindset can change from these experiences.
Because our core belief is that you can’t completely outsource your finances. It’s like asking a doctor to handle your diet and exercise. Will your dentist brush your teeth and floss for you? Will your doctor do your push ups or eat your kale? Bad or good, your own decisions and actions define your life.
“… having the right tools and having a plan … is more beneficial … than simply having a professional check in once a year”
Your Health Comes Down to What You Do with It
The truth is a doctor will operate to save your life and a dentist will fill your cavities. But if you wait for the doctor or dentist without a plan of your own, it might be too late to avoid the pain.
The revolution we’re after in tax and accounting is a change of skillset and mindset in our clients.
Because as a tax and finance expert, I’ve learned that having the right tools and having a plan for how to use them, is more beneficial in the long term, than simply having a a professional check in once a year. Leaving your health completely in the hands of someone else can be a recipe for failure.
So why do people do exactly that with their money life?
Why do would-be entrepreneurs wait for someone else to jump on their idea, rather than grow a business?
Why do celebrities wait for bankruptcy to swap luxury for savings (see Johnny Depp’s wine spending)?
And why do small businesses wait until the IRS comes after them to set up their tax defense and offense?
If you’re standing by watching money in and money out without any tools or resources, chances are that reality will catch up and make you take stock of what you have (and owe).
It’s Not Good… And It Gets Worse
Don’t just take our word for it. The average American has $17,000 in credit card debt, $30,000 in an auto loan, more than $50,000 in student debt, and pays between 15% to 25% of their income in taxes (including federal, state, and sales taxes). That means that the average American making $75,000 a year, assuming standard financing on debt, and after taxes, has $30,000 of actual income to live — that’s 40% of your hard-earned money. In business, 8 out of 10 entrepreneurs fail within the first 18 months, according to Forbes. And even the failed businesses will pay taxes along the way (Uncle Sam says thanks). This is what being average looks like.
If you want a better money life, you have to do the extra push ups. You cannot be average.
You have to put in the work to become money good. That does not mean learning everything. It does mean learning the right tools and using them.
Below we’ve provided 3 key steps to that better money life.
“While other metrics may be critical (users, traffic, etc.), none of those will matter if you’ve had no sales all year, very negative income, and no cash on hand.”
Step 1: Own Your Numbers
I’ve seen too often, young entrepreneurs so absorbed in the day-to-day of operations that tax and finance gets dropped. I have clients that are neurotic about website traffic and conversions; others who take pride in closing all outstanding invoices; and some who love the technical work they do in their business. All of these preferences are fine, so long as you don’t lose hold of the numbers.
Because if you’re a business owner and you don’t like your numbers, then a salaried job may be a safer bet. That’s not meant as an insult, it is honest advice. Because as the boss, as the main employee of your ship, YOU have to live, breath, and sleep your numbers. The same goes for parents and anyone else looking to have a family one day.
So how do you “own” your numbers? Simple: track them. Whether it’s in an excel sheet (you can check out our templates), or in an accounting system such as Wave Apps or Quick Books Online, set up an account where you can at any point see — at a minimum — your 1) sales, 2) net income, and 3) cash on hand. You can have an accountant get into the details of each of those, but be able to “own” your numbers by speaking to those for the month, quarter, or year. While other metrics may also be critical (users, traffic, etc.), none of those will matter if you’ve had no sales all year, very negative income, and no cash on hand.
Whether you’re a business person or not, if you’re not looking at your spending in relation to income projections (how much you expect to earn), or looking at your investments in relation to the long-term, and the tax impact of all those, then you’re leaving a whole lot to chance. Just see our numbers on debt, business failure, and tax above.
“If you can’t measure it, you can’t improve it.” – Peter Drucker
Step 2: Create A Baseline Stat Sheet (Tracking)
Once you’ve set up your accounts, establish a routine to check in on the numbers. Set a reminder in your calendar and do it. For both individuals and businesses, checking cash balances is something you probably already do. While we agree that knowing and setting goals for cash balances is important, we also recommend looking at other factors to construct a more complete picture of your money health.
For individuals, we recommend the following top 3 statistics:
- Debt to asset ratio = (Debt) / (Assets)
To calculate, you’ll need to add up all your asset and debt accounts. Those include all your retirement accounts, your checking and saving accounts, liquid stocks, credit cards, lines of credit, and student loans. In our experience, many who are new to assessing their financial health will struggle with finding where all this information is collected, log ins, company names, and so on. If this is you, we want you to realize this quickly: the only place all your financial information can be centralized is with you. Don’t tell your CPA or tax professional that you ‘Don’t know where that account is’ or if you have another ‘Retirement account.’Do this for short-term assets (cash) and debts (credit cards) and then, for long-term assets (retirement accounts) and debts (student loans and mortgages), separately. Talk to a loan officer about what a “good” ratio is for a first-time buyers and use that as an external source for what is “good.” Generally, you want to target having no more than 20%-40% of debt to assets, however, keep in mind that you’ll need to keep income expectation in mind. Sometimes the whole point of taking on debt is to create even more income in the future (e.g., short-term rentals, loan for educational purposes), which most would agree is a viable way to grow your income.
- Net Wealth = (Long-term + short-term assets) – (Long-term + short-term debt)
Get a sense of what you “net income” is by subtracting your total liabilities from your assets. Finding balance is key. Having no money today but a very large 401(k) perhaps suggests irresponsible spending habits that will also one day (maybe before retirement) deplete your long-term assets. Likewise, if you have more short-term wealth, than long-term wealth, you’re very likely not planning for future (and missing out on some tax breaks). This is what Certified Financial Planners get so excited about.
- 3-Year Income Forecast = (Projected Income Year 1 + Year 2 + Year 3) – (Lifestyle Expenses x 3)
The point of this calculation is to look forward and determine, ‘If I kept my expenses constant, what change in my net worth can I expect from changes in my income over the next three years?’ The critical points here is to realize that A) we can’t kick the financial can down the road: Year 3 is today. And B) that we need to keep our lifestyle expenses down to get to where we want to go, faster. (Finance wonks will comment that you should present value the future income, however, since we’re keeping expenses constant, over three years, we’re really assuming Years 2 and 3 represent some change (increase) in future income.)
If you want sample tools to grow your personal finance, be sure to send us a request here.
Here is a list of the top 5 stats we track to measure business health:
- Sales Growth Month-over-Month and Year-over-Year = (New Sales – Old Sales) / (Old Sales)
How do you keep score when you’re winning? Sales is a good start, and understanding how that’s changing requires a time-period based rate.
- Gross Margin & Operating Margin = (Gross Profit) / (Net Sales) & (Operating Margin) / (Net Sales)
From small business loan officers to hedge fund managers, these ratios gauge where costs hit the profit and loss statement the most. Do we have a profitable product with lots of overhead? Or do we have a lean organization and product with razor-thin margins? Having a good sense of both is essential for those CFO-level observations.
- Profitability Ratio or Berry Ratio = (Net Revenue – Total Costs) / (Total Costs)
This ratio looks at the mark-up on total expenses your business is earning. It is essential to compare this to similar businesses for financial and tax purposes to understand your performance relative to your peers. For tax, having a low mark-up compared to the industry average, can trigger an audit.
- Cash on Hand (Days) = [(Cash x 365 Days)/(Operating Expenses)]
You think these numbers are pretty important to a start-up, or any new business? You bet. Knowing how long cash will keep the business afloat is critical for setting sales goals and ensuring the company doesn’t lack the cash flow to maintain operations.
Look to industry standards for these metrics and compare industry averages with you’re own. After one quarter you should have the expertise to sense where you need to grow and where you’re already doing well.
“You’re probably writing a generous check to the government…”
Step 3: Set New Goals & Make a Plan
After you’ve seen the trends, now is the time to set new ones. It’s hard to communicate what the value of this in one blog post. The point of step 2 is to understand where you’re at and once that’s accomplished the next question is, ‘Where do my numbers need to go for me to have the life I want.’ If you’re already where you want to be, then the focus should be on maintaining those metrics. However, I feel pretty strongly after meeting over 1,000 tax clients, that if you’re reading this right now, you’re dead set on growth.
Goal-setting seems to be something right out of a self-help book. But be careful to confuse day dreaming with raising the bar for your money life. You probably already have seen the future in terms of the things you want: a new car, a house, that vacation for your family. Now it’s time to see the quantitative version of that vision.
Keep on innovating, measuring, and setting your sights on better goals. You never know what you might find along the way.