India is a country of entrepreneurs and self-employed people, whether they are farmers or owners of small family-owned businesses and establishments. According to official estimates, nearly 50 percent of Indians in the working age group are self-employed. And if we add farmers to this group, the proportion would be almost 80 percent. This is a very large number compared to other major economies.
The trend towards self-employment has only got stronger in recent years due to the weakness in the job market, a decline in manufacturing and faster growth in the service sectors. This means that millions of Indians either start their own business every year or join their family enterprise.
All these budding businessmen and the self-employed require financial planning to keep their finances in order and retire comfortably in old age.
The financial planning advice in India is however largely geared towards salaried people who have a steady monthly income.
In contrast, most self-employed people have highly variable incomes with distinct busy and lean earning seasons. This makes it tough to cut and paste the advice tailor-made for salaried people on the self-employed.
But it’s even more important for the self-employed to do active financial planning as they lack the social security and retirement benefits available for the salaried such as provident fund, gratuity, paid sick leave, group medical and life insurance and post-retirement pension.
Self-employed professionals and businessmen have to plan and save for these financing benefits on their own accounts. Financial planning is however not rocket science and anyone can do it provided they are financially disciplined and follow some general rules. If there is doubt they can also seek professional advice.
Here are some general tips for the self-employed to keep their personal finance in top shape.
1. Don’t mix the personal and business accounts: In family-owned businesses or a one-person operation such as professional consulting, it’s convenient and even tempting to maintain a single bank account for all incomes and expenses whether they are for personal expenses or business-related income and expenses. This is a recipe for a financial disaster in the longer term.
Start financial planning by creating two bank accounts – one for receiving personal income and paying out personal and family expenses and the other for your business-related transactions.
The basic idea is to create a salary-like structure for yourself so that the income or the surplus that you earn from the business can be invested in the right financial instruments to secure your family’s long-term financial health.
This will help you keep a live track of the financial health and cash flows of your business and also de-risk or hedge your personal or family finances from the ups and downs of your business. This may sound odd, but every business should be structured in a manner that if it was to ever go bankrupt, it shouldn't jeopardise the finances of the promoter or his family. This is only possible when there is a separate account for personal and business purposes.
2. Save and invest to smoothen out your income. Irregularity and uncertainty in income and cash flows are perhaps the biggest bugbears for the self-employed. This is especially true for younger and immature businesses. Too much volatility in income can make it tough to make financial plans both at the business and individual levels.
Self-employed individuals can use the surplus income in busy seasons or their income spikes to invest in financial assets to create a secondary source of income.
This will help them even out the cash flows during the lean season. For example, mutual funds offer income plans that are specifically created for this purpose. You can also invest in tax-efficient financial instruments such as monthly income plans from the post office, non-cumulative bank and corporate fixed deposits, high dividend yield stocks, or life insurance products that offer period income.
3. Seek advice from financial and tax experts. It’s very tempting for the self-employed to invest all their savings and personal funds in growing their business. This is not advisable and your business should not grow at the cost of your personal and family’s financial health and stability.
It’s best to seek professional advice from financial and tax consultants about the right course on business funding. They will give a third-party unbiased view of your business as well as your personal finances. They will also help you ring-fence your personal income and assets from the assets and liabilities of your business. Correct professional advice will be a lifesaver in the unfortunate case of a legal or tax dispute in your business.
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4. Keep family members well informed. In a salaried job, most employers have complete information about the immediate family members of the employee. This makes it very easy and legally possible for the organisation to reach out and provide financial help to family members in the unfortunate event of an accident, health issue or death of the employee.
In contrast, many self-employed people operate as islands. This creates financial and legal complications for the immediate family members such as spouses and kids in case of an emergency.
Given this, financial transparency with the spouse and other family members is vital for the self-employed.
They should keep their immediate family members well informed about major business transactions and aware of all key assets and liabilities. One option is to have nominations and joint holding of investments and ownership from day one itself. You can also seek professional advice from lawyers and financial advisors to smooth out this entire process.
5. Make a financial will and plan for succession. Most self-employed professionals and businessmen invest outside their business on a personal account in traditional assets, such as precious metals, real estate, and other alternate and non-traditional investments.
As they are kept out of the books of the business and not held jointly with other family members, these can become a source of friction in the family in the unfortunate case of their demise.
A financial will along with a plan of succession will ensure a smooth transfer of assets to the next generation and will also allow the continuity in business and other financial and non-financial investments.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).