Finance & Grow Your New Business. Angie Mohr

will you have to put into your retirement fund each year between now and age 60 to have that amount available?

      We will use a 6 percent average return for our calculations.

      How much will you need at age 60?

      This is simply a mathematical calculation that involves the present value of an annuity. To calculate, you multiply the annual income required ($50,000) by the appropriate factor. Multiplying by this factor takes into account the fact that future dollars are not worth as much as today’s dollars. At an interest rate of 6 percent and 30 annual periods, the factor is 13.765. Therefore, the amount that you need to have in retirement savings by the time you are 60 is $50,000 x 13.765 = $688,250. In most cases, this won’t have to come solely from savings. You may have pension income from a job or a 401K. Your business will also likely have a value when you sell it to retire. Be careful about making these assumptions too rosy in case they don’t happen. In this scenario, we will assume that the entire retirement fund is coming from savings.

      How much do you have to put away between now and retirement?

      You know that you will need $688,250 by the time you turn 60. You have 25 years to save that amount (at an assumed 6 percent rate of return). How much will you have to sock away every year to meet your goal? Again, the formula is simple mathematics. We now use the future value of an annuity to calculate the payments. Using a 6 percent interest rate and 25 periods, the factor is 54.865. You divide the required retirement fund amount by the factor to come up with the annual payments into the fund. In this case, it is $688,250 ÷ 54.865 = $12,544 per year that you will have to tuck into your retirement fund in order to meet your retirement goals.

      So, why is this information important to you now, when you are starting up your business? It’s important when you set your business financial goals. You now know that if you want to meet your personal retirement goals, you will have to draw enough from your business not only to cover your current living expenses, but also an extra $12,544 per year to fund your retirement. Many small-business owners have retirement goals that are at odds with what they are making from their businesses. The earlier you integrate these goals, the more likely you will achieve them.

      The Concept of Net Wealth

      How much are you really worth? You may be drawing a large salary from your business but if it all gets spent on current expenses, it doesn’t add to the value of your possessions. One of the most important measures in your personal financial planning is your net wealth. This is simply your assets minus your liabilities. Over time, your assets should grow and your liabilities should decrease, which decreases the risks you are exposed to and increases your financial stability. Ultimately, your net wealth is what you have to live on and then to pass on to the next generation.

      It doesn’t have to be onerous to track your net wealth. You can simply write down your best estimate of the value of all of your assets and then the payout amount of all of your liabilities (i.e., the amount of money it would take to settle up your debts). You may also choose to use a software program that will track not only your net wealth but also your income and spending. It may also track your retirement savings. Popular programs such as Intuit’s Quicken or Microsoft Money make the tracking easy. If you do this on a regular basis (monthly or at least annually) you will be able to see how your wealth increases over time.

      Your assets may include:

      • Cash

      • Portfolio investments (bonds, stocks, etc.)

      • Your home

      • Other real estate (cottages, vacant land, rental properties, etc.)

      • Vehicles

      • Savings (including retirement accounts and college funds)

      • Your business

      Your liabilities may include:

      • Mortgage

      • Credit card balances

      • Personal loans

      • Car loan

      The higher your net wealth, the more likely a bank will look favorably upon your business as it needs financing.

      Debt Management

      In order to make sure that you will manage your business debt appropriately, it’s important to first get a handle on your personal debt.

      There is an old adage about good debt versus bad debt. Bad debt is defined as any debt you undertake to purchase things that do not grow in value. This would apply if you’re using your credit card or line of credit to go on a vacation or buy living room furniture or a car. Good debt, on the other hand, is debt that’s incurred to invest in things that will grow in value, such as your home, other real estate, and stock market investments. Conventional wisdom says that bad debt should be avoided or paid down as quickly as possible, but good debt is acceptable and should even be pursued.

      The problem with this outlook is that it does not recognize that debt means risk for you, regardless of what that debt buys you. Any time you have required payments to make, you run the risk of not being able to pay them and thereby becoming insolvent or even bankrupt. When you borrow to invest, either in real estate or in bonds or the stock market, there is no guarantee that these investments will increase in the short term, which is when you have to make the payments. There is a danger that, if the value of the investment drops below what is owed on the loan, the loan will be called. In that situation, even if the investment is sold, you will still owe money.

      Another investment “nugget” suggests that paying interest on investment loans in order to build investment assets is a good idea. As we have discussed above, all investment entails risk, whereas paying down your debts can give you a greater return on an after-tax basis. Let’s look at an example:

      Your spouse has received a $5,000 bonus from his employer. You are considering whether to invest that in your investment account or to pay off the last of your credit card debt. Currently, the long-term investment return from stock investments is about 6 percent. You will have to pay taxes on part of that income, however, and therefore, your after-tax return may be as low as 3 or 4 percent. On the other hand, your credit card company charges 19 percent. Paying off that card will give you a 19 percent return after tax, as there are no tax implications of paying off debt. Not only is your return much higher, paying off debt gives you that return risk free. It’s a guaranteed return. Always keep this in mind when trying to decide what to do with windfalls and extra money in your budget.

      I’m certainly not advocating that you do not have any personal debt whatsoever. Simply keep in mind that debt equals risk. As a small-business owner, you will be exposed to plenty of risk as it is, without adding to it on the personal side. Here are some things that you can do to get a handle on your personal debt situation:

      1. List out all of your personal debts, the terms left on them, and the interest rate.

      2. Rank your debts by highest to lowest interest rates. You will find that the highest interest rate debts are generally credit cards, retail cards, rent-to-own situations, and payday loans. The more the debt is secured by underlying assets, the lower the rate will be. For example, because the bank can take back your home if you do not make the mortgage payments, mortgage rates tend to be lower because the risk to the bank (not to you!) is lower.

      3. Review your budget and calculate how much you can set aside for debt repayment.

      4. Make a formal debt repayment plan. For each debt, you should know how long it will take to pay off (not just the minimum required by the lender). Start with the highest interest rate debts and pay them off as quickly as possible.

      5. Stick to your budget! Make sure that you make the payments that you have calculated every month in order to be out of debt when you have planned to be.

      Your Credit History