The Waterfall Money Management System for Business Owners

Many of us, once our business starts to go cash flow positive consistently and starts to produce some solid gains, are unsure at first of what to do with the money that is being produced.

Below I am going to go through the system that I use, that has helped us stay organized, hit every payment on time, and double our savings in the last year without thinking about it.

We call it the Waterfall system because you are taking the river of money you make from your business and or job, and separating it out into little pools downstream, much like a waterfall.

Before we jump in: we are not the first to advocate these ideas. The Envelope System is very old, and the book Profit First is very popular. This system is a combination of the two, and we have included lots of visuals to help make this easier to follow along. With

Below is the overview of the full system, and we’ll be diving into each piece.

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For Your Business

The cash path for your business looks like this

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Your business has revenues that comes from sales, those come in to hit your bank account.

There are 5 steps to figuring out what to do with this $:

1 - What % of Money goes where

2 - When do I separate the Money

3 - Where do I separate this money

4 - How do I know how much to send

5 - Moving from Business to Personal $

So, let’s start on step 1

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What % of Revenue goes where

Assuming you do not have any crazy debt obligations or cash flow problems, here’s what you can do:

1 - run a profit and loss statement by % of income over the last 12 months.

2 - Find the number at the very bottom next to Net Income.

For examples sake, let’s say our Net Income as a % of Revenues is 30%.

That number is the percentage of each dollar of revenue that is profit. Aka that's the money your business produces and does not need to function.

We also now know that 70% of each dollar we earn we need, and 30% we do not need to run the business.

So now you want to fill out a little spreadsheet like this that shows what to do (by percentage) with each dollar received.

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Here’s how you get each number:

Operational: Net Income as a % of Total Income, last 12 months.

Taxes: Find your Predicted tax bracket here, then Multiply your % Net Income number by that number. Let’s say you are going to put 100K as your taxable income, according to the 22-23 numbers your tax bracket is 24%. So 0.24 * 0.30 = 7.5% (ish). This is a guideline not a rocketship just get close and put that money aside (which we will show you how to do in one second).

Business Savings: If you don’t have one, this is the break in case of emergency / cash reserves / future business investments bucket. To keep things simple we are just going to put this at 12.5%. Simplicity is key here don’t make this hard

Owners Profit: That I usually just recommend as whatever is left you get. This is on top of payroll and whatever salary you may be taking because that is baked into your Net Income % number (if taking a W2 salary). If you are not taking a W2 salary, it means your compensation is not baked into your Net Income % number, and so your pay is going to come out of this bucket.

These have to total 100%.

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When do I separate this Money?

Pick two days throughout the month. I do the 8th and the 22nd.

This is the easy step

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Where do I move this money to?

You are going to set up multiple bank accounts.

You want one checking account for each of these buckets:

Income - all revenue comes in here

Operational - all expenses go out of here

Taxes - don’t touch

Business Savings - don’t touch

Owners Compensation - for you!

Now, where can you find a bank that will allow you to open 5 checking accounts with low or no fees?

Credit Unions. I honestly have no idea why but they are the easiest banks to work with, have great customer service, and typically really good online banking.

When you go search for this, you want to call through credit unions in your area and ask these questions:

1 - can I set up a new checking account on my own through online banking

2 - Can I name my checking accounts in the online banking portal

3 - Are there any fees involved with having a checking account

Find yourself a bank or credit union where the answers to the above three are 1 - yes, 2 - yes, 3 - no and you’re live.

Sign up for an account and make your different “Buckets” within your online banking.

Side note - Savings accounts do not work as they cannot send and receive money as easily. You need checking accounts.

Side note #2 - yes, this is the hardest part and will take some time to research and set up accounts and get new debit cards and all that.

Side note #3 - how do you switch banks? Connect your old one to your new one, transfer the funds over, change all your auto-pays to the new one. Pretty easy

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How do I know how much to send?

Ok so now we have our spreadsheet, our processing dates, and our accounts set up.

Let’s do our first Waterfall Run

Step 1: Get the total amount of $ in the Income account (this is where your sales deposits should be going)

Step 2: Break out the total $ by your %’s of Use from your spreadsheet.

For examples sake, let’s say we had $1000 in income. So that becomes:

70% Operational $700

7.5% Taxes $75

12.5% Business Savings $125

10% Owners Compensation $100

So you now have a dollar amount for each bucket.

Now, in your online banking portal, transfer those dollar amounts from the income bucket to the 4 other buckets.

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Moving from Business $ to Personal $

So, now that you have your business funds separated, two final steps to wrap up the Business side of this equation.

First, you need to set up a savings account at a different bank (can also be a checking account) for your “Gov $ Vault.”

Make sure that you do not have a debit card at the Gov $ Vault. If they send you one cut it into tiny pieces and then burn it.

What do you do with this Vault? Well after you do your Business Waterfall, all the money that is now in the taxes bucket…..Send to the Gov $ Vault.

Why do this? Well you have already approximated your tax bracket for the year. Thus, a portion of your income is going to be going to the government…and it’s not yours to spend.

Thus, the Gov $ Vault reminds you and sets up just that - a place where you store the money that you owe the government. Use it when you pay your taxes and for nothing else.

Part 2 of moving from Biz to personal is to send over the balance of “Owner Compensation”  to your personal “Income” account (we’ll run through the personal side setup in just a second).

So, do that at the end of your business waterfall. Send everything in Owner Compensation over to your personal Income bucket, however many % points you decide that may be.

And Voila, you have a system to manage and sort your Business cash flows in a fast and easy way!

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Personal $ Waterfall System

The Personal $ Waterfall system is similar to the business system, with a few important changes.

To start - it is a good idea in my opinion to treat your personal finances exactly like a business.

The goal of this business is to acquire assets and produce as much cash flow as possible. Pretty much like any other one.

So, let us begin.

Your Personal Business, we will call it “Me LLC” or “My Family Corp”, gets revenues from activities like running a business and having a job.

There are 5 steps to determine what to do with those revenues.

0 - Recommended Account Setup for Personal $ Waterfall System

1 - Am I making money in this business right now

2 - What % of Money Goes Where

3 - When do I separate the Money

4 - How do I Separate the Money

5 - How do I Keep Track of All this Money

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Step 0- Recommended Setup for Personal $ Waterfall System

Checking Accounts:

2 of them at the same bank for personal checking. One titled Income and one called Spending.

Recommend Charles Schwab here. No-Fee setup and No-Fee ATM’s which is great for traveling.

All other accounts:

This is really up to you if you want credit cards, savings accounts, investment portfolios for stocks, etc. This is not investment or financial advice in this post, just a system to use to organize your money.

At the very end of the post we will run through some situational questions regarding personal accounts and recommended solutions.

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Step 1 - Am I making money in this business right now.

Is Me LLC making money? Here’s how to figure this out:

1 - Sign up for Personal Capital at this link → personalcapital.com

2 - Connect all of your bank accounts

3 - Wait for them to pull in all your transactions

4 - Comb through all transactions to make sure they are categorized correctly

5 - click Cash Flow, then set the date to “1 Year”, then look at your Monthly Average.

6 - If your monthly average is above 0, you are making money. If your monthly average is below zero, you are losing money.

If Me LLC is losing money each month that means you are piling up personal debt, and I would highly recommend chopping expenses down and focusing on earning as much money as possible to reverse your situation.

If you are losing money this system will not work for you as it is for use with profitable cash flowing enterprises only.

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Step 2 - What % of Money Goes Where

Your Revenues are high enough that you are making money. Good! Now, how to separate it.

(Side note - we are going to be introducing some new account names here. We address how to set those up later in the post.)

First off, find your average monthly Expenses balance from Personal Capital.

Go to Cash Flow, click Expenses, set the timeline to 1 Year, then see your monthly average.

Now, create yourself a little spreadsheet like this (you can also do this on paper) and we’ll walk through how ti figure out what to do with your cash

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Here’s how you get to each number:

- Spending. This is the money you need to buy things like food, rent, utilities, daycare, insurance, gifts and a few fun things for yourself / the fam. Use your Monthly Average from Personal Capital, divide it by two, and multiply it by 1.1. As we are going to be running this Personal Waterfall also bi-monthly, the reason for this is to cut the cash flows in to two pieces, and then to also add in 20% for fluctuating expenses.

You should get a solid $ amount here, not a percentage.

Side note on spending. I like to exclude medical bills from this number as that is typically paid out via an FSA/HSA. This is a whole website’s worth of a rabbit hole, but if you say had a child recently, that doesnt happen consistently, so I have removed that from our 2022 numbers.

- Savings. This is really up to you

- Investing. This is also really up to you.

And here is how they work together.

When you go to run your Personal Waterfall, you see how much money is in your income account. You then transfer Income Balance - Spending Requirement to the Spending account. You then do what you wish with the rest (not a financial advisor).

Here is what this looks like. Let’s assume my monthly spending + buffer is 4K/month, and so my waterfall spending amount (half of the total cause we do this twice per month) is $2,000 USD.

When I go to run my waterfall, I look at my Income Account. There is $3000 in there.

I immediately transfer $2000 to my spending account cause I know that I need that to survive.

The other $1000….Do with that what you wish! As of this writing the author is saving up cash to grab some real estate in 2023, so all our surplus goes to that for right now.

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3 - When do I separate the Money

You can either do this at the same time or alternatively to your Business Waterfall. The author does every other week.

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4 - How do I Separate the Money

Very simple, just log in to your online banking institution and transfer the money around.

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5 - How do I Keep Track of All this Money

Also simple. Once you have Personal Capital installed, you can check out your dashboard on your phone and keep track of things (expenses, income, cash flows per month, portfolio performance, etc.)

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Why the Waterfall System Works & How to get started

As with many systems, if the foundational principles are set up and thought through, the system will function well through many inputs.

The Waterfall system works because of a few things:

1 - it is flexible and can change as your situation changes. It also works for the whole range of income levels

2 - it moves money from one big pile into a bunch of smaller buckets. For some reason this helps us make better decisions and not overspend, because we can actually see - in it’s own bucket - what we can spend.

3 - You only spend 15 minutes on this per week (about) after getting this set up. You can even do it from your phone. Fast, Easy, Mobile.

4 - It really should not cost anything to do, it just takes a little effort.

We will drop in some situational questions below and add more as time goes on.

To get started, I would first start with your business accounts as that for many of us is the headwaters of our cash river (so many metaphors!). Start upstream and work downwards.

If you made it this far - hope this is helpful! Also please see the video and the graphics to help explain all of this in a visual way for people (like the author) who prefer to see pretty shapes and colors.

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Situational Questions and How to Solve them

Q: I have a small business and a job, can I still use this system?

A: Yes, funnel your job compensation into the Personal Income bucket. Put your Owners Comp from the business into the income bucket as wel.

Q: How do credit cards fit in to this system?

A: If you are using credit card(s) in your business, hook it up on auto-pay to your Business Operations Account. If you have a credit card(s) for yoru personal $, hook it up to your Personal Spending account.

Q: My spouse and I use one account together, what should I do in this situation?

A: Connect your spouse's Job / Business income to go into the Personal Income bucket. Besides that everything else is the same

Q: My spouse and I both run a business, should we combine our business accounts?

A: No.

Q: I own multiple businesses, what should I do?

A: Each business should have its own set of accounts. Do not combine business accounts as that makes it much more difficult (albeit not impossible) to get accurate financial data. All business compensation flows into your Personal Income bucket.

Q: I do not own a business, can I still use the Personal side of this system?

A: Yes.

Q: Can I just have my accountant / bookkeeper set this up for me?

A: Potentially, yes, but they will need to have access to all of your sensitive personal information, so be prepared for that.

Q: What happens if I really need extra cash for my business and I do not have it in the Operations Account?

A: This happens so worth discussing. First off, as a fact, if you spend more than you make this system does not work and you will go broke. Second, when you do run in to this situation, what you should do first is at your next waterfall session (if it can wait), do not separate the Savings, Owner Comp, Taxes. Just send it all to opex. If it cannot wait for some reason (and usually it can wait if you ask - the vendor would rather be paid next week than not paid at all), then go straight into the income account today and transfer ir all over. If the sum is even more than that you can consider touching the savings account, but I would then try to go to a payment plan with whatever is going on (except if it is payroll. It it’s payroll make sure you move heaven and earth to get people paid). Last step here is to remember the stress and anxiety from this period and use it as a motivator to not do this again.

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