Living Margin for Business

The Living Margin framework for businesses, integrating management accounting and bank balance accounting, aims to create a balanced and disciplined financial management structure. Here’s a detailed breakdown of the framework:

1. Owner Compensation

  • Range: 20-50% of revenue

  • Variability: Dependent on industry standards and specific business circumstances.

  • Purpose: Ensures the business owner adequately compensates, providing financial stability and motivation.

2. Operating Expenses

  • Range: 40-70% of revenue

  • Breakdown:

    • Payroll and Cost of Goods Sold (COGS): Maximum of 60% of revenue

  • Purpose: Covers all essential operating costs, ensuring the business runs smoothly without financial strain.

3. Profit and Taxes

  • Range: 10-40% of revenue

  • Variability: Dependent on the industry and whether the business is owner-operated.

  • Purpose: Ensures sufficient funds for profit reinvestment and tax obligations, promoting business growth and compliance.

Application

To apply this framework effectively:

  1. Assess Industry Standards: Understand typical percentages for compensation, operating expenses, and profit margins within your industry.

  2. Customize for Your Business: Adjust the percentages within the ranges to match your business model and financial goals.

  3. Regular Review and Adjustment: Continuously monitor financial performance and adjust allocations to maintain balance and meet business objectives.

Example Scenario

Assume a business generates $50,000 in monthly revenue. Based on the framework, the allocation could be:

  • Owner Compensation (20%):

    • $50,000×0.20=$10,000

  • Operating Expenses (60%):

    • $50,000×0.60=$30,000

    • Within this example, a maximum of $24,000 (80%×$30,000) can be spent on payroll and COGS.

  • Profit and Taxes (20%):

    • $50,000×0.20=$10,000

  1. Adjust Spending: Operate the business within the $30,000 budget for operating expenses. This ensures financial discipline and prevents overspending.

  2. Regular Review: Review the financial performance at the end of each month or quarter. If actual revenue varies significantly from projections, adjust the percentages accordingly.

Benefits of the Framework

  1. Financial Discipline:

    • By setting aside profit and compensation first, you enforce a discipline that prevents overspending on operating expenses. This method ensures that the business is profitable and sustainable.

  2. Visibility and Control:

    • Having separate accounts for different allocations provides clear visibility of where your money is going and helps control spending more effectively.

  3. Avoiding Debt:

    • The framework discourages borrowing from future revenues or other allocated funds, which helps avoid debt and maintain financial health.

  4. Consistent Compensation:

    • Regular compensation ensures that you, as the owner, are rewarded for your efforts and can maintain a stable financial situation.

  5. Financial Stability:

    • By prioritizing profit and compensation, the business builds a buffer that can be used for growth opportunities or as a safety net during lean times.

  6. Habit Formation:

    • The framework encourages forming good financial habits by re-prioritizing how funds are allocated without drastically changing your spending habits. This makes it easier to stick to the plan.

By following the Living Margin Framework for Business, entrepreneurs can achieve a balanced and sustainable financial management system supporting business growth and personal financial well-being.

One-Time Setup for Business 

Step One: Set Up Two Bank Accounts

  1. Checking Account 1: For Owner’s Compensation and Operating Expenses

    • Revenue Deposits: All business revenue should be deposited into this account.

    • Owner’s Compensation: Deduct your salary or payroll from this account.

    • Operating Expenses: Pay all business-related expenses from this account.

  2. Checking Account 2 or Savings Account: For Profit (Savings) and Profit Distributions

    • Profit Savings: Set aside a portion of your profits into this account.

    • Profit Distributions: Make monthly or quarterly profit distributions from this account, which can be rolling or linear based on the account balance.

Step Two: Determine Target Allocation Percentages

Using the Living Margin suggested allocation percentages (20-60-20), determine reasonable percentages for your business. These percentages will guide allocating funds between owner’s compensation, operating expenses, and profit savings.

Example Allocation:

  • Owner’s Compensation: 20%

  • Operating Expenses: 60%

  • Profit Savings: 20%

Integrate Living Margin Formula for Cost-Cutting

Use an accounting program to track all your bank and credit card transactions to manage your operating expenses efficiently. Here’s how to proceed:

  1. Update Financial Accounts: Ensure your bank and credit card accounts are up-to-date in your accounting program.

  2. Run Financial Reports: Generate reports to review your financial status.

  3. Cut Recurring Costs: Identify all recurring costs and reduce or eliminate unnecessary ones.

Additional Tips

  • Regular Review: Review your allocation percentages and adjust them based on your business performance.

  • Track Expenses: Keep detailed records of all expenses to ensure accurate financial management.

This structured approach will help you manage your business finances efficiently, ensuring a balance between compensation, operational costs, and profit savings.

Simplified Method for Single-Owner with No Employees

If you prefer a simplified approach, you can use a single business account and follow these steps:

  1. Adhere to Target Allocation Percentages: Allocate your revenue according to the percentages for owner’s compensation and operating expenses.

  2. Transfer Profit Distribution: At the end of each month, transfer 50% of the profit savings to your personal checking or savings account.

Example Scenario:

  • Business Revenue: $10,000

  • Target Percentages: 20% Owner’s Compensation, 60% Operating Expenses, 20% Profit

  1. Deposit Revenue:

    • $10,000 deposited into Checking Account 1.

  2. Allocate Funds:

    • Owner’s Compensation: $10,000×0.20=$2,000

    • Operating Expenses: $10,000×0.60=$6,000

    • Profit: $10,000×0.20=$2,000

  3. Transfer Profit:

    • Transfer $2,000 to Checking Account 2 or Savings Account for profit distribution.

By following these steps, businesses can achieve a structured and disciplined financial management system that supports operational efficiency and personal financial stability. The Living Margin Framework ensures that profits and owner’s compensation are prioritized, promoting long-term sustainability and growth.

Monthly Business Tasks Checklist

Income Management

  1. Deposit Receipts:

    • Ensure all sales or service receipts are deposited into the business checking account.

Allocation and Adjustment

  1. Review and Adjust Target Allocation:

    • Review your target allocation percentages.

    • Adjust percentages incrementally as necessary to meet targets.

  2. Owners' Compensation Review:

    • Check the percentage allocated for owners' compensation.

Payments and Expenses

  1. Pay Owners' Compensation and Operating Expenses:

    • On the 10th and 25th (adjusted to your revenue collection and/or accounts payable dates) to pay:

      • Owners’ compensation.

      • Operating expenses.

    • Ensure payments do not exceed allocated percentages.

    • If cash flow is insufficient, adjust and plan accordingly.

Profit Management

  1. Monthly Profit Distribution:

    • At the end of the month or the first day of the new month:

      • Take 50% of your allocated profit as distribution.

      • Keep the remaining 50% in the business checking/savings account as a reserve.

    • Profit distribution should not be reinvested into the business. If you need to loan this money to the company in critical situations, document it clearly, as this indicates cash flow issues and can have personal financial impacts.

Adjusting Operating Expenses for Tax Payments and Profit Allocation

  1. Covering Shortfalls:

    • If operating expenses and liabilities exceed available funds, use the profit account to cover the shortfall.

    • Adjust future allocations to replenish the profit account.

      • Cost-Cutting Measures

        • Identify all recurring costs in your operating expenses.

        • Cut unnecessary expenses to maintain a lean operation and improve profitability.

  2. Adjust Operating Expenses for Tax Payments:

    • Review your tax obligations for the month/quarter.

    • Reduce your profit percentage by the tax amount to ensure adequate funds for the next period.

      • Adjust your allocation percentages accordingly:

        • Owner Compensation: Adjust based on needs and tax reduction.

        • Operating Expenses: Increase to cover the tax payment.

        • Profit: Reduce to accommodate the increased operating expenses.

  3. Allocating Excess Funds:

    • Moving the remaining amount to your profit account after covering owner compensation, operating expenses, and debt/liability payments.

    • At the end of the month, take 50% of the remaining profit as a distribution.

  4. Building a Cash Reserve:

    • Aim to have at least three months of operating cash in your profit account.

    • Once this reserve is met, decide on the use of any overage:

      • Reinvest in the Business: For growth and expansion.

      • Additional Profit Distribution: Allocate to personal financial goals or leisure activities, like a family vacation.

  5. Regular Meetings with a Living Margin Coach:

    • Schedule periodic meetings to review and adjust allocation percentages.

    • Focus on maximizing financial health through strategic adjustments:

      • Evaluate current financial status and needs.

      • Adjust owner compensation, operating expenses, and profit percentages to ensure sustainability and growth.

Example Allocation Adjustment

Suppose your initial allocation percentages are:

  • Owner Compensation: 30%

  • Operating Expenses: 50%

  • Profit: 20%

After calculating your tax payment for the next quarter, you realize you need to allocate an additional 5% to operating expenses to cover this. Your adjusted percentages might be:

  • Owner Compensation: 28%

  • Operating Expenses: 55%

  • Profit: 17%

At the end of the month, if you have excess funds, you move it to your profit account. If your profit account now holds three months of operating cash, you can consider:

  • Reinvesting the overage into the business for new projects or equipment.

  • Taking an additional profit distribution to meet personal financial goals or enjoy leisure activities.

Regular adjustments and strategic financial planning will help balance business needs and personal financial goals.

Living Margin For Business Review

  1. Set Revenue Percentages:

    • Determine and set specific percentages of revenue to be allocated to owner's compensation, profit, and operating expenses. For example, you might allocate 10% for profit, 20% for owner’s compensation, and 70% for operating expenses.

  2. Separate Accounts:

    • Open separate bank accounts for each category (owner's compensation, profit, and operating expenses). This physical separation helps visualize the funds available for each purpose and prevents mixing funds.

  3. Allocate Deposits:

    • Allocating the predetermined percentages to the respective accounts immediately after revenue is deposited ensures that profit and compensation are prioritized.

    • Review your target allocation percentages for owner’s compensation, operating expenses, and profit.

  4. Adjust Spending:

    • Base your operating expenses on the funds available in the operating expenses account. This helps in automatically adjusting spending according to what is available after profit and compensation have been set aside.

    • Adjust these percentages incrementally as needed to reach your target allocation.

      • If adjusting for tax payments, reduce the profit percentage accordingly and ensure adequate allocation for the next month/quarter.

  5. Regular Reviews:

    • Conduct regular financial reviews to ensure the allocated percentages are still appropriate for your business’s financial health. Adjust these percentages as necessary based on business performance and goals.

  6. Profit Distributions:

    • Schedule regular profit distributions (monthly or quarterly). This will provide an incentive for maintaining profitability and help you consistently reward yourself.