Business Planning Start-Up Guide
This is part three of operations. We’ll focus on bookkeeping in this step. Accounting, legal entities, and taxes all converge on good and proper accounting. The decisions you make while setting up your books cannot be changed without the approval of the Internal Revenue Service (IRS). You’ll have to decide on the Cash or Accrual Accounting Method and, if you carry inventory, your Inventory Method.
I have a relative who did not take his bookkeeping seriously. He saw it as something that made him “crazy” so he just ignored it. In no time he could not account for those who owed him money payable in 30 or 60 day out. When it came to completing his first year’s taxes, he did not have all his receipts; therefore, he had to pay more income taxes than he should have. You cannot just say, “I spent $100 here and $50 there” and deduct it on you taxes. The IRS requires receipts and proper accounting.
To my relative’s credit, he later said, “Good accounting is almost as important as advertising.”
Cash or Accrual Method
The Cash or Accrual Method will affect how you’re taxed by the Internal Revenue Services ( IRS). In the accrual method you record payments, expenses, or sales at the time they occur, whether you received the payment, expense, or sale now or later. In the cash method, you record the transaction once you get the payment or spend the money. Most small start ups will chose the cash method but, if you are a C-corporation, you have to use the accrual method.
The IRS has a publication that explains it. Consider reading it to understand the pros and cons of each method. Of course, this is the where you should consider selecting an accountant, as well. He or she will help keep you on the straight line when it comes to the IRS.
At tax time, the IRS doesn’t care when you’ll get paid or when you expense, they consider it done. That can have some consequences on your financial bottom line and your tax bill. The worst case would occur when you made a big sale but are paid 90 days later – in the next tax year. In this case, the IRS will expect “their” money before you’re paid.
The benefit of the accrual method is aligning transactions during the period from which they occurred. This helps the business better predict cycles and forecasting because you know exactly when the events occurred.
If you hold inventory for sale or production, you’ll have to account for it on your income taxes. With inventory, you receive items throughout the year or years and have to account for their acquisition cost. In the past, it was impossible to track every individual item and its acquisition price. So a method was devised to value inventory as a group. In the United States, there are two (primarily) methods to value inventory: LIFO or FIFO. Last-In-First-Our or LIFO is considered tax advantaged in times of inflation. First-In-First-Out or FIFO is consider tax advantaged in periods of deflation. I recommend reading these Wikipedia articles about inventory and accounting methods.
Your accountant should be consulted when deciding which inventory methods you’ll use.
Not too long ago, some small companies would consider using a paper bookkeeping system. This is no long a viable choice. There is just too much time lost with the paper system (in my opinion). You’ll want to consider using some form of software to keep track of all your receipts and sales. If you’re still small, you can use spreadsheet software like Microsoft Excel or Google Docs spreadsheets to keep track of sales and expenses.
What system you use depends on many factors, but I really suggest consulting with an accountant on this matter. If you’re using an accountant, you’ll want to use software that is compatible with his or her accountant’s system. Your accountant will be able to import your books into his/her system, thus saving you a lot of hours billed. You’ll need this information for tax fililng.
Your first business software purchase should be a capable and reputable accounting system. In a perfect world your cash register, online sales, accounting, and other systems and software would communicate seamlessly. It may not be obtainable goal, but whatever you do, try to reach this goal as close as you can.
Don’t purchase a system solely on today’s price, unless you cannot avoid it. It may be cheaper, but I suspect it will cost you in time, productivity, frustration, and knowledge later on. Don’t purchase quicken or other personal financial software. They are not true accounting systems and you need to understand accounting. You’ll eventually have to convert to a better one anyway. That is a headache!
Your accountant will likely recommend Intuit’s Quickbooks or Sage (Peachtree) Accounting. If you want to save a little, buy an older version (not too old). Most accounting software have an online version which you pay monthly for. That’s not a bad choice if you’re concerned about cost.
I was impressed with these Cash Method few cloud (online) accounting software services: GoDaddy Online Bookkeeping (formerly Outright) for $9.99 per month; Wave is free, but has advertising and it is Accrual Method of Accounting (though an end of year journal entry is an easy work around – remind your accountant or tax professional). Then there’s QuckBooks online, which offers Simple ($9.99), Essentials ($19.99), and Plus ($29.99) monthly packages. Finally, I thought Sleeter had a review that’s worth reading through, cloud accounting review.
Since we’re talking accounting and bookkeeping, who will do your books? Will it be you, a bookkeeper, or an accountant. You can easily do it, but do not consider it unless you understand what you are doing or get solid advice from your accountant. If this is you, train yourself to do it correctly, right from the start. Get a book or consult with your accountant.
There are a number of good bookkeepers who will perform bookkeeping services for you. If you use you accountant, it may be the most costly. But, be sure to find an experience one. One with good references.
Whomever you chose to do you books, be sure you DO NOT WAIT until the end of the year to consider one. You need to keep your eye on the books throughout the year to ensure you are meeting your financial goals. If you do your own books, you should do them regularly. I suggest doing them weekly or monthly. Never less than quarterly. Never. Especially since you’ll probably have to pay quarterly payments to the IRS.
If you wait longer than a month, you will forget to collect receipts, you’ll misplace receipts, and even forget to pay your quarterly taxes. It’s just poor management to not watch revenue and expenses. If this is you, get a bookkeeper and/or an accountant.
If you cannot follow this suggestion, then get a job: you are not a real businessman or businesswoman. You are delusional and likely the the best candidate for an IRS audit. Financial stress often leads to failed marriages and failed businesses. I’m not exaggerating.
Separate Bank Accounts
As I mentioned earlier, you will not co-mingle your personal and business finances. Your first step toward that goal is opening a (small) business bank account. Shop around because banks like to charge handsomely for this services.
You will use this account to pay all your bills and to deposit all your sales revenue. If you pay yourself, you will actually write a check/transfer to yourself from this account. In fact, if someone pays you and you want to keep the money, you’ll first deposit it into your business account and then write a check to yourself.
Get into a habit of doing this and you will not be tempted to do otherwise. The IRS loves it; and those that may want to sue you hate it. They’re hoping you’ve pierce the corporate veil. You must protect your personal assets from business problems as much as possible.
You will also use separate credit cards to pay for your business affairs, for the same reason. If you must purchase something with your personal account, reimburse yourself as you would if an employee is reimbursed.
Since we’re talking about the IRS and audits, this is a good seagway to sales tax, employment taxes, and quarterly tax payments. I’m actually not going to go too deep into this because you need to do your own research. Each state is different. Just know this:
- Do your books regularly.
- If you have employees contact your state’s tax commission/department so you’ll understand your responsibilities.
- If you sell retail, you probably have to pay sales tax (only a few states don’t have sales tax).
- If you have employees, you’ll have to withhold taxes, pay social security taxes, workman’s compensation insurance, and a few other taxes routinely.
- If you make a profit, you’ll likely have to pay estimated quarterly taxes to the Federal and state governments.
- If you don’t, you’ll likely owe a lot of taxes at the end of the year.
- If you don’t, you’ll likely be behind (big time) on your tax bill.
- If you don’t, you’ll likely be penalized.
- If you do all the above, life will be good and you’ll sleep well and have a future.
You can chose a tax year for your business. One that’s different than your personal taxes. However, if you file business taxes under 1040 Schedule C (for sole proprietors), you must keep the same tax year because you business will be filed on your personal 1040 tax forms. For partnerships or entities, your business taxes will passes through to your personal taxes. You company will distribute 1099 Forms to its members or partners.
For easy, I use the regular tax year, ending December 31st. You may want to, as well.
For single member LLSc, the IRS considers your business (for tax purposes) as a Disregarded Entity and you’ll file on Form 1040, Schedule C. Non-single member LLCs will file IRS Form 1065 and corporations will file Form 1120.
Some business will send out and receive Form 1099s for transactions they made throughout the tax year. Form 1099 is an formatted summary of taxes, deductions, and fees. Most of us receive 1099-INT from our banks but there are many different types of Form 1099s. Check out this list of IRS 1099 tax forms on Wikipedia. Just like employee W-2 forms, most 1099 Forms have to be mailed (distributed) by January 31st, though there are some exceptions.
Budgets and Financial Planning
Funding Your First Year of Operations
By this point, you should have already considered how you’ll pay your business bills, before you have sufficient income to cover all of its expenses. If you haven’t, now is the time.
In fact, I suggest that you decide on a dollar amount and deposit it into your business’s bank account. This is called a contribution to owner’s equity. For LLCs, it’s called a contribution to member’s equity and for corporations its to stockholder equity. When you take it out, it’s called a withdraw or return of equity. Earnings are called distributions.
Since you have a capable bookkeeping software application, you can easily budget your expenses with an eye on you spending and earning patters. If your software has a budgeting function, I suggest using it and then printing it and positing it in an accessible binder or on the wall to keep you conscious of it.
As you spend and earn revenue, you should be watching your books weekly and monthly. Compare activity quarterly and if possible year-over-year (last year with this year). After your first year, review your successes and failures and not only make adjustments to operations, marketing, etc. but to your financial plan.
However you do it, operate from a sensible budget (based on real costs and operations). You’re in business, so act like it. Right?
If you are doing everything right, you’ll eventually start taking a drawl from you account for a “salary.” I suggest keeping as much in the company to expand if at all possible. The more you take out, less you’re able to mature, expand, and earn more sales.