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Can You Really Pay Yourself First? 

by | Dec 30, 2023

In the world of personal finance advice, there’s an adage that says you should “pay yourself first.” This means prioritizing personal savings and investing before spending money on personal needs and wants. 

In a business context, it’s not as simple as grabbing 10%-20% of the profit number on your P&L. Even though you’re a shareholder in your business, you don’t have first dibs on what’s left after you bring in revenue and pay all the bills. CPA Greg Crabtree describes the “Four Forces of Cash Flow” in his excellent book Simple Numbers, Straight Talk, Big Profits! These four forces are:

  • Taxes 
  • Debt 
  • Cash reserves 
  • Distributions 

In short, shareholders are the fourth in line when it comes to getting money out of a business. Let’s explore each of these forces one by one.

1. Taxes 

Taxes are such a fact that we have sayings like “…death and taxes.” When you make money, the government has the first claim on your profits. Many ODs don’t like paying taxes (actually, almost no one likes paying taxes).  

That said, tax rates are public knowledge. With timely optometry bookkeeping and good accounting advice, there’s no reason for your practice to be surprised by your tax bill, which is the most common reason taxes cause a cash crunch. A great habit is to fund a separate account each month for your quarterly estimated taxes or annual tax bill. 

Not paying taxes or stretching the limits of deductions might seem tempting, but running afoul of the IRS is one of the most expensive and painful issues a practice owner can face. So the smart move is to plan for and pay your taxes. 

2. Debt 

The bank is the second entity that gets paid from a practice’s profits. Like taxes, debt is also predictable because using financing to buy equipment or pay bills is a choice you make. Using a credit card or line of credit to pay for things is also a choice you have.

If you aren’t using cash for large capital purchases, fixed installment loans are a great option because you know exactly what you owe each month of the loan’s term. For example, I prefer a three- to five-year loan for equipment purchases over drawing against a line of credit.

Revolving debt, such as lines of credit or credit cards, should be handled with care. It’s best to pay down lines of credit within three months, ideally within days or weeks of drawing on them. Credit cards should be paid off every month. Carrying a balance on credit cards or a line of credit can become a persistent drag on cash flow because every free dollar goes toward paying the outstanding balance. 

3. Cash Reserves 

We’ve already discussed how to calculate an appropriate operating reserve, so here we’ll only note that your practice should have sufficient cash to fund upcoming obligations before taking distributions. 
Thinking through reserves is especially important if: 

  • You’re experiencing rapid growth, and your payroll and bills are growing along with revenue. 
  • You’re in a partnership because multiple owners wanting to get paid can put pressure on cash reserves. 
  • You have a predictable business interruption coming up, like an OD on maternity leave, moving locations, or changing your practice management software. 

4. Distributions 

Finally, once taxes are accounted for, all debt is repaid, and we ensure the practice has enough operating cash, it’s time to pay the shareholders. Paying taxes and servicing debt is important, but it’s equally important to distribute any excess cash to the shareholders.

One reason for doing this is that leaving excess cash in your practice isn’t the best use of it. Often, simply moving cash into a personal account can greatly enhance the interest rate you get. It can also prevent making poor decisions like impulsively buying new shiny instruments just because there’s cash available.

But the main reasons to move cash out are to diversify your assets (go buy some eggs from a basket that isn’t your practice) and nurture the value of your practice. Consider this: a common method of valuing businesses is a discounted cash flow. Without getting into the nuance of how that’s done, flowing cash out of a business is a key component. 

Keep Things in Order 

Independent optometry practices don’t often encounter cash flow problems, but when they do, it’s usually due to not planning for taxes or failing to take debt obligations into account before taking out cash. Keep these four forces of cash flow in mind to reduce the stress caused by tight cash and plan for regular cash flow distributions. 

If you’re looking to optimize your optometry practice’s cash flow, our expert team of bookkeepers at Books & Benchmarks is here to help. Contact us today for personalized assistance and guidance in managing your financials.

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