Businesses live or die, survive or thrive based on how well they handle their money – especially in their pivotal early years. Even if your revenue figures are very respectable, your business is only ever one cash flow crisis away from being brought to its knees. So it’s absolutely vital that you get used to setting money aside for specific purposes. This is the essence of earmarking.
The term earmarking is used in a number of different contexts, inside and outside the realm of commerce. Here we’ll look closely at the term, its meaning, its origins and why it’s important for small businesses like yours.
What does “earmarked” mean?
When funds are set aside for a specific purpose or project, they are known as “earmarked”. This prevents the funds from being spent in other areas, thereby maintaining healthy cash flow.
The term earmarking actually has its roots in agriculture. Farmers would cut a notch into the ears of their livestock. This would help them to identify their own animals.
Businesses can earmark funds in a number of different ways such as keeping them in a separate bank account or even keeping them in escrow to prevent them from being consumed by other aspects of their operational spending.
Examples of earmarking
We see examples of earmarking all the time in the world of business and beyond. For instance, local governments will often earmark funds to pay for roadworks or park.
When a person or business becomes insolvent, earmarking is essential to ensure that liquidated funds are distributed properly among creditors.
Of course, we also earmark funds all the time in our personal lives. We decide what money in our accounts is and is not fungible all the time. Our ability to allocate funds and prioritise transactions is as essential to household budgeting.
Earmarking in politics and taxation
Earmarking can be (and is) leveraged for political reasons, and politicians can be swayed by the promise of allocating (or the threat of withdrawing or repurposing) earmarked funds. In the US, this is known as “pork barrel spending”.
In the UK, portions of tax revenues can be ring-fenced or earmarked for a specific purpose. A good example is the National Insurance system, whereby both employers and employees pay a portion of tax into the NI fund. The NI contributions are used to pay out welfare benefits such as statutory sick pay and unemployment benefits. Another example is the TV licence fee that pays for the BBC, which actually received the vast majority of its funding directly from the government, rather than members of the public who must pay the fee if they own a TV.
Why is earmarking important for businesses?
Earmarking is absolutely essential for small businesses. Unless funds are properly allocated for investment in inventory, payroll and capital investments, it can lead to the first steps down a slippery slope.
An inability to earmark funds can lead to missed payments to vendors that could sour a business relationship. It can lead to payroll issues that demoralise employees and shake their faith in your company. It can prevent you from being able to make investments in equipment or personnel that could take your business to the next level.
How you earmark your funds is entirely at your discretion. From keeping funds in escrow to obtaining a separate bank account or even mental accounting (not recommended). However, you do it, it’s an essential habit to get into.
We can help
If you’re interested in finding out more about earmarking, cash flow management, or any other aspect of your business finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.