How To Avoid Insolvency When Starting Your Own Business As A Tradesperson

Create a business plan 

Every successful business starts with a realistic plan. This forces you to really do your research before you take on the risk of starting your business.

One of the things we see all the time is that entrepreneurs realize too late that running their own business was never going to be as lucrative as they had first imagined. There are plenty of hidden costs to running a business. Your business plan should include a conservative projection of your revenues and realistic estimate of your expenses. Consider talking to others with sucessful businesses in the same field to get an idea of costs and risks you might not have thought of. Things like:

• overhead
• hiring accountants and other professionals (which should not be avoided, as we will discuss later)
• employee-related costs like WCB and the employer's portion of EI and CPP
• taxes - this one is huge. Chances are if you have seen someone go off to start their own business and suddenly have way more money than they had as an employee, they are spending their gross revenue and forgetting to remit tax.

The plan should also account for a slower start-up period. Many new contractors expect to be fully booked immediately, but building a client base takes time, and often includes extra start-up costs at the beginning. You may have to put personal funds into the business for a while, so you need to know what you can afford to put in before you get started.

The plan should also consider goals and and strategies for managing financial risks.

All of this might sound stressful, or perhaps boring. If so, now is the time to seriously consider whether you have the right personality to operate your own business. Being honest with yourself right now about your strengths and weaknesses and what you actually enjoy will help you ensure that being a business owner is the right fit before you take on the financial risks associated with going out on your own. Running a business requires a completely different skill set than performing a trade, and your day might look very different as a business owner rather than an employee. Preparing a business plan is a great exercise to help you do some soul-searching about whether running a business is really something you would do well and enjoy.

Prepare a cash flow forecast

One of the most important financial concepts for any contractor is cash flow. Cash flow refers to the timing of the money moving into and out of your business. Even if your business is profitable, delayed customer payments can leave you without enough money to cover payroll, supplier invoices, insurance premiums, fuel, or loan payments.

Poor cash flow is one of the leading reasons businesses experience financial distress. Even very successful companies have been taken down by cash flow issues.

Before you get started, you will need to understand the timing of your cash flows so that you can ensure you have enough funding (either through personal funds or by borrowing from a bank) to get through periods where your cash going out is higher than your cash coming in.

Through this exercise, you may come to realize that it is going to take longer than you thought for you to be able to afford to pay yourself. Alternatively, you may be able to come up with plans to manage cash flow to avoid issues, like delaying purchases or taking on small quick-cash jobs. You will also gain a better understanding of the importance of collecting deposits from customers and being proactive about getting paid in a timely manner.

Get the right people and structures in place

Many entrepreneurs wait until they're facing significant financial challenges before asking for help. In reality, seeking professional advice even before you get started can help you avoid business insolvency altogether.

Yes, it is cheaper to do everything yourself, but building a plan around saving money by not hiring professionals is a mistake that will have consequences eventually. The most sucessful people "know their lane" and stick to it, delegating tasks that are not in their skillset to people who are better than them at those things.

Working with accountants, bookkeepers, lawyers, payroll administrators, marketing professionals (or whatever other type of professional might be relevant for your field) will increase your startup costs, making it take longer to turn a profit. However, not doing so significantly increases your risk of making a major mistake and becoming insolvent in the long term.

If you are not willing to relinquish some control to delegate to experts, while still managing those experts like staff (don't forget - the buck stops with you!) then you may want to reconsider whether you have the right personality to run your own business.

Keep your business and personal finances separate

Opening a dedicated business bank account and using business credit cards for company purchases helps you maintain accurate business bookkeeping throughout the year, making it easier to know how your business is doing.

Avoid using business accounts to pay personal expenses whenever possible, as this not only makes it hard to know how the business is really doing, but it also creates accounting issues that can cause problems at tax time. Instead, pay yourself a consistent salary or owner's draw based on a financial plan developed with your accountant.

Price your services for profit, not just competition

Many new contractors believe offering the lowest price is the best way to attract customers. However, underpricing can lead directly to financial hardship. It's tempting to compete with others who may be driving their business into the ground by taking on losses to win jobs. However, any experienced business person will tell you it is not worth winning customers who care only about the lowest price - they will not be good customers in the long term. Instead, make decisions that are good for your business in the long run.

Make sure you are bidding jobs based on covering all of your costs, not just the visible costs of each project. This includes overhead costs like insurance, administrative time, accounting services, equipment replacement, licensing, fuel, vehicle depreciation, continuing education, marketing, and taxes. 

Then, you will need to build in enough room for a profit, as this is how you will get compensated. And don't forget that your compensation will be taxed also, so you need to charge enough to be able to live on the after-tax profits from the business, as well as build up cash in the business for any future business investments you want to make.

Diversify (or, don't put all your eggs in one basket)

Even if things are going very well, things can turn badly quickly if you have put too much faith in one thing that suddenly changes. Some examples:

• having only one or two customers that make up most of your revenue. If they go out of business, run into cashflow problems and stop paying in a timely manner, or a new manager takes over and wants to use a different contractor, you may suddenly find your business scrambling. 
• relying heavily on a key employee. If they leave or get sick, you may struggle to keep the business going. Likewise, your risk of being defrauded increases if you put too much responsibility in the hands of one person.
• having only one piece of key equipment. Perhaps the size of your business does not support having more than one of a key piece of equipment, like a truck or expensive tool, but you should have a backup plan in case it breaks down.
• you, as the business owner, should not keep all critical information in your head. If you become incapacitated, you will want your employees or emergency contacts to be able to keep the business going until you are able to return.

Consistently review the business's financial situation

Preparing a business plan and a cash flow forecast should not be a one-time thing. You will learn as you go, your industry will evolve, and the economy will fluctuate. Regularly review and adjust your business plan and cash flow forecast so that you can capture these changes.

Keep your bookkeeping and financial statements up to date. Don't assume that your business is making money just because it appeared it would when you priced your jobs. Unexpected costs can mean that you are losing money even if you are keeping busy and doing good work, and the timing of cashflows can sometimes mask this. Keeping the accounting up to date and reviewing it regularly will ensure you know the reality of the business's finances.

Take a look at how the business is doing with fresh eyes and be ready to adjust. You may need to raise your prices, increase the amount of deposits you are taking, cut staff or other costs. Or you may need to hire more (or better) professionals to support the business. It's important you make these adjustments before your business becomes hopelessly insolvent.

It's also important that you continually re-consider whether it makes sense to continue on with the business. Sometimes, the economic or competitive environment makes it impossible to sustain a healthy business. Or, sometimes it becomes clear that you are not the right person to be running a business. People often keep going long after they should have closed the business - whether due to shame, an unwillingness to admit that it isn't working, or a simply because they feel they've already invested too much (look up the "sunk cost fallacy") - only to dig themselves into a deeper hole financially.

Make tax remittances up front

Taxes are one of the most common financial challenges facing new business owners. We regularly see business owners get into trouble in these situations:

• Failing to remit payroll taxes held back from employees, and instead using the cash to fund their business expenses. Let me be clear: this is not your money. It belongs to the government, and if you do not remit it, there are immediate penalties and interest, and you will be personally liable for paying it.
• Failing to keep GST returns up to date, and therefore not remitting the net GST collected from customers (minus GST paid on expenses). Again, this is not your money. It belongs to the government, and if you do not remit it, there are immediate penalties and interest, and you will be personally liable for paying it.
• Failing to hold back a portion of profits to cover the taxes on those profits. Any profits your business makes will be subject to tax. The mechanism for assessing and collecting the tax will differ depending on whether you've structured the business as a sole proprietor or a corporation, and whether you are taking the profit as a dividend or a salary. That is for your accountant to figure out. But ultimately, the government will get their piece. And they will likely find a way to come after you personally for it even if you incorporated. 

In order to avoid getting into tax trouble, it is critical that you keep your tax filings up to date and remit taxes immediately, not at the end of the year. One of the most common errors we see is business owners waiting until tax time to figure out what they owe and then scrambling to find the cash to pay it, because they didn't hold the money back throughout the year.

This is where professional help can be very useful. For example, if you have employees, using a third party payroll administrator can ensure the taxes are calculated correctly and remitted directly to the government. An accountant can keep your GST filings up to date and let you know what you need to remit on a monthly or quarterly basis. And your accountant can help you structure your personal compensation in a way that minimizes taxes and ensures you know what you need to pay and when.

If you can, remit installment payments to the government on a monthly basis based on your accountant's calculations. Alternatively, you could open a separate savings account specifically for taxes and transfer a percentage of every customer payment into it. The worst thing you can do is spend your gross profit throughout the year. Not only will you find yourself without cash to pay your taxes at tax time, but you will also become accustomed to living on a higher income than you actually earned.

Avoid inadvisable debt

Some debt can help your business grow. Financing a reliable truck or purchasing equipment that increases productivity can be a worthwhile investment. However, debt increases risk. And debt can quickly become overwhelming if revenue slows or customers delay payment. Before you take on debt, ask yourself:

• Will this generate additional revenue or just cover losses? If it is covering up losses, it is probably not a good idea. Reconsider your business plan. Taking on debt to try to save a business that isn't salvageable only digs you deeper into a hole.
• Can I comfortably afford the monthly payments? Consult your up-do-date cashflow forecast
• What happens if business slows for several months? Run sensitivity analysis on your cash-flow forecast by playing around with amount and timing of cash in-flows.

Being a successful entrepreneur is all about taking risks. But taking on debt may be more risk than you can truly handle. The less debt your business carries, the more flexibility you'll have during economic uncertainty. Ensure you have thought it through before you take on debt.

Build an emergency fund

Unexpected expenses are inevitable.Your work vehicle may require major repairs. Equipment may need replacing. A large client may delay payment. Seasonal slowdowns can reduce incoming work. Even the best cashflow forecast can't predict all. 

Without financial reserves, these situations often force business owners to rely on expensive credit or shut down. Rather than taking all of the profit out of your business, consider building up some cash in a savings account for the business, to cover unexpected expenses or periods where you aren't able to bring in enough work.

Seek professional advice early

Many entrepreneurs take pride in being in charge of their business and dealing with any obstacles that come up. This sometimes means they wait until they're facing significant financial challenges before asking for help. In reality, seeking professional advice early can help you avoid business insolvency, or at least minimize its impacts.

Your accountant or lawyer is a good place to start, but if the business is in significant financial distress, you should reach out to a Licensed Insolvency Trustee (LIT) for a free consultation. Even if you aren't ready to close the business or make an insolvency filing, an LIT has the skills and experience to provide some valuable insight that will help you decide how to move forward. They are also typically well-connected and can refer you to other professionals where appropriate.

Seeking advice early gives you more options, and often better outcomes.

Starting your own business takes skill, determination, and hard work. Building a successful business requires those qualities along with sound financial management. Healthy trades business finances aren't about making the most money as quickly as possible, they're about creating a sustainable company that can adapt to changing economic conditions, invest in future growth, and continue serving customers for years to come.

At Charla Smith & Company, a Calgary-based Licensed Insolvency Trustee serving the southern Alberta region, we see the impacts when tradespeople start a business without a solid foundation. We get directly involved to help when things have gone awry, but we also try to use education to help prevent that happening. There is always risk, but with careful planning and informed financial decisions, you can reduce the risk of business insolvency. If you'd like some advice about business debt, please reach out to us.

Disclaimer: This publication provides general information and should be seen as broad guidance only. The information contained herein cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon this information without obtaining specific professional advice relating to your particular circumstances. Charla Smith & Company Ltd. does not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.