A report earlier this year by Service Seeking, a website dedicated to tradies, found that 9% of tradespeople make more than $200,000 a year. Sounds dazzling doesn’t it? This figure is the gross amount, though, and not the net income they are bringing home at the end of the day. It might be a goldmine, but the business owner doesn’t necessarily own the gold. The same can be said of anyone with a business bringing in lots of cash.
As an accountant and wealth coach who specialises in working with business owners in the trades industry, I often see tradie businesses take off very quickly after an initial start-up phase. Quite often, things plateau out shortly after, and cash flow problems start to present, particularly where they have borrowed money for capital equipment or to try to trigger further growth. Whilst these initial acquisitions may be enhancing income, the debt funding drains cash flow and slows momentum.
The good news is that if you have a business, there are a few ways you may be able to leverage it to build wealth.
Three golden rules
Before we look at some of the smart decisions you can make to grow your personal wealth portfolio, there are three things to remember when it comes to making money in business.
- Turnover and cash balance is not the same as profit.
- Moderation is key – there is no medal for growing your business too big and business owners do not need to set out to build an empire.
- Business is all about balancing your resources to match your revenue goals, so you can leverage the success of your business and translate this into your own personal wealth.
You need to know your numbers first
To start establishing your wealth portfolio, you have to know what you are working with and this begins with understanding your existing financial position. It is imperative that the money coming in and going out for your personal expenses is scrutinised, much like a profit & loss statement is when assessing the performance of a business.
First, create a ‘personal wealth’ accounting file (essentially a budget) which captures all your income and expenditure data. This will give you your personal profit & loss. The formula is simple: cash in less cash out equals a surplus/deficit. If it shows a surplus, things can only improve from here. Alternatively, if you are in deficit, you should try to identify the reasons for that and address them promptly.
Here are some things you could do to enhance your position:
- Creatively maximise and introduce new income streams.
- Shave away unnecessary spending and negotiate discounts.
- Using your surplus, project the number of years it will take to achieve a goal.
Overheads can’t be avoided, but how are you funding them?
Many businesses – especially a trades business – have significant overheads. Purchasing materials and capital equipment to set up and maintain a trades business can be eye watering, with many of the requirements being big ticket items.
The majority of these costs are incurred just as the business is starting out. For example, there are tools and machinery or specialised plant equipment that run up into the tens of thousands of dollars.
The majority of the time there is also the need to outlay on a ute, van or truck – most of which need to be fitted out with tool safes and equipment boxes. When you add ongoing costs to the mix, the money going out can accumulate quicker than the money coming in.
Many tradies worry that if they don’t have all the tools and equipment from the outset that they will miss opportunities, so they spend up big, sometimes unnecessarily, and most times too quickly. The money they sink in is often from their personal savings, loans, or worse – credit cards.
A lot of businesses, and business owners personally, are over-extended because they don’t look at their numbers and plan ahead in line with where they stand financially. Down the track they look back and wonder where has the money gone, why am I short of cash, and what do I have to show for all my hard work? This is why it is so crucial to understand your numbers before you do anything.
Step up to hammer down – start with securing your home.
Ideally we should only use debt for assets that go up in value. It can be a good idea to start with a home and aim to pay this down first, thereby securing a roof over your head. Once you own your home (or almost), you may want to use debt to acquire growth assets as additions to your wealth portfolio. This is called ‘stepping up’.
You step up into assets that appreciate in value, such as property, as opposed to assets that depreciate, such as vehicles and the like. The debt enables you to enter a market that may be otherwise inaccessible to you. Once the asset is in place, you then strive to hammer the debt down, as fast and as streamlined as possible. Your priority is to constantly move your assets into the positive. After the debt on each asset is paid down, you can step up again.
Over time this process presents you with a string of healthy debt-free investments in your wealth portfolio which feed from each other, accumulating capital growth and passive returns. This is a very comfortable place to be.
Using business income to build passive income. Dual income families get there faster.
In many situations with tradies in business, we find that the husband is on the tools and the wife/partner is working behind the scenes in an admin capacity. In the early years, it can be difficult for a family business to generate a double wage, and this puts the family under financial pressure.
We tend to find the dual income families – where one partner maintains a part- or full-time wage external to the family business – are the families that tend to do best in the personal wealth zone.
A strategy that we often apply with a dual income family is setting them up to live on one partner’s wage. This wage pays for the lifestyle and the business owner’s wage is paid directly from the business to the house mortgage, or if the house is paid off, to an investment mortgage. The business owner’s wage is silently building up their wealth portfolio behind the scenes, and they don’t miss it. It just happens. By diverting one wage, it simply isn’t there for the spending.
Passive income is the key to wealth and the path to financial freedom
Let’s face it, our economy is volatile to say the least at the moment, and trade and industry have not been spared from the downturn. What will you do if your active income is taken away from you overnight?
One of the key elements in accumulating wealth and having freedom of choice is passive income. Passive income is money that you make while you’re sleeping, as distinct from active income, which is made from personal effort. Passive income comes from holding investments such as property or shares as they grow and generate earnings ‘passively’ in the background, while you are busy at work.
Over time it is sensible to acquire multiple revenue streams. These may be a mix of active and passive. When faced with a change in market conditions or an economic downturn, multiple income streams have you well prepared, as the loss of one income may be backed up by another.
The primary focus of a wealth portfolio is capital growth. Your portfolio is ideally made up of a combination of smaller investments with high capital growth potential. In most instances, rental return and tax breaks should be considered a secondary ‘bonus’.
With any investment there is normally a minimum of a seven to 10 years holding period for it to be a worthwhile addition to your profile. Each and every investment is a long-term decision. You need to have patience to allow your investments time to grow, to avoid losses and achieve the best results. The stronger (and safer) your assets, the more lucrative your portfolio, and the more protected and financially secure you will be.
Cover image source: LightField Studios (Shutterstock)
About Leah Oliver
Leah Oliver is founder of Minnik Chartered Accountants. She is a qualified Chartered Accountant, Registered Tax Agent and Public Practitioner, with extensive experience in accounting and finance. Leah is also a wealth educator who wants to teach people how to build a smart portfolio.