Whether it’s turning that pet grooming side hustle into a full-time gig or it’s creating a dating app for seniors, starting a business is a thrilling experience for any first-time entrepreneur.
But while creating your company logo and hiring your first employee is certainly fun, starting a business also comes with some less-than-exciting responsibilities. Namely, bookkeeping and filing taxes.
When you’re just getting started you might be tempted to just figure out your accounting stuff down the road. But that would be a mistake.
Entrepreneurs who start out neglecting their financial responsibilities often find themselves in hot water.
So, to help you get a handle on your bookkeeping and taxes before get burned, we’ve rounded up seven essential financial management tips that every entrepreneur should know before they even choose their business name.
1. Never Mix Business With Pleasure
When it comes to business finances, it probably seems like common sense that your personal and business expenses should be separate.
However, in practice, it can sometimes be tricky to stick to this rule. Just imagine that you’re at the office supply store and you need to buy ink for both your office printer and home printer.
For most people, it might seem easier to simply put everything on one card and then sort it out later.
In fact, nearly one in five business owners admit that they do not even have separate personal and business bank accounts.
While a little bit of overlap between your business and personal finances may not seem like a big deal at the moment, this seemingly harmless behavior creates big bookkeeping problems.
Though the IRS doesn’t require you to use any specific record-keeping method, it does require you to make sure you to maintain accurate documentation and a clear audit trail.
If you’re frequently drawing money from different accounts, it will make it more difficult to properly record your income and deductions.
Co-mingling your finances can also lead to big problems at tax time.
According to the IRS, only businesses can deduct business expenses. Therefore, if your business expenses are actually coming out of your personal bank account, you may be giving the IRS the impression that your business is actually a hobby.
If you get audited, you’ll have a hard time convincing the IRS that you’re actually operating a business and that your deductions are legitimate.
2. Start With The Proper Accounting Method
When it comes to running a small business, it’s not just a matter of tracking money coming in and money going out. Rather, it’s the timing of when you record income and expenses that impact how you manage your business finances.
In other words, you need to know whether to use cash or accrual-basis accounting before you start making any sales.
If you’re using cash-basis accounting, you only record income and expenses when money has exchanged hands. This means that if you bill someone for a project, you would only record the money as income when it hits your account. The same goes for expenses.
However, with accrual-basis accounting, income is recognized when it is earned and expenses are recognized when a bill comes in. This means if you’re hired for a project, you would record the income as soon as the work is completed—even if the client has not actually paid you yet. You would also record expenses as soon as each bill arrives.
Choosing whether to use cash or accrual basis accounting affects your bookkeeping because it changes how you make day-to-day financial decisions and how you budget for the future.
While each accounting method has its pros and cons, choosing accrual-basis accounting often gives you a more accurate picture of your business finances and performance.
Accrual accounting is also generally better from a tax perspective because you can claim business expenses on the tax form for the year you incur expenses, rather than in the year you actually pay them.
But regardless of which method you choose, it’s important to stay consistent in order to maintain accurate financial records.
3. Digitize Those Receipts
Even if this is your first business venture, you probably know that you should get a receipt when purchasing things for your business. This could include expenses such as office furniture or fuel for a business trip.
The problem is, many business owners don’t have a system in place for organizing those important receipts. There’s a reason that the “shoebox full of receipts” is a cliche because it’s unfortunately quite common.
This is where technology can lend a hand.
Entrepreneurs can avoid the nightmare of trying to store their receipts by using dedicated apps to digitize their financial records.
For instance, apps such as Receipt Bank or Hubdoc allow you to use your phone to scan physical receipts and create digital copies. These apps will then properly categorize each transaction and store the information in the cloud.
For bookkeeping purposes, the info on your digital receipts can be sent directly to your accounting software, completely eliminating the need for any manual data entry.
During tax time these digital receipts become very handy.
The IRS requires you to keep documentation that backs up the income, deductions, and credits you report on your tax return, so having digital copies will keep you organized.
Instead of sifting through a shoebox full of paper, you can simply search your app for a digital record.
4. Think Like A Lawyer
In the midst of starting a business, there are quite a few bureaucratic hurdles that may require you to navigate the legal system. However, few entrepreneurs give thought to the legal structure of their business before starting out.
This is a problem because the legal structure of your business not only impacts how you file your taxes but also how much you’ll end up paying the government.
In the US, businesses fall into one of five categories listed below:
- Limited Liability Companies (LLCs)
- S Corporations
- C Corporations
- Sole Proprietorships
In the past, filing as an LLC was often (though not always) viewed as the best option for entrepreneurs because of the significant tax advantages. However, with the recent passing of the Tax Cuts and Jobs Act (TCJA), there are fewer benefits to filing as an LLC.
In other words, choosing the right legal structure for your business is not as straightforward as you might think, which is why it’s important to research the advantages and disadvantages of each legal structure before starting your business.
If you have a better idea of which legal structure your company fits into, it will allow you to keep appropriate records and plan for tax time accordingly.
5. Make Deductions Work For You
As mentioned above, receipts are necessary in order to claim business deductions. However, what’s even more important is actually knowing what you can and cannot deduct before you spend the money.
If you’re new to the world of small business ownership, a “tax write-off” is a business expense that you can deduct from your taxable income.
Essentially, these write-offs allow you to pay a smaller tax bill, as long as they fit the IRS’ definition of a deductible expense.
Generally, the rule is that you can deduct all “ordinary and necessary” business expenses.
For instance, you can deduct the cost of ordering new chairs for your office or the cost of running Facebook ads promoting your newest product.
However, it’s equally important to know what you cannot write-off before you spend copious amounts of money.
For instance, if you think that gifts are deductible, you might send $75 gift baskets to every new client. In reality, you can deduct no more than $25 of the cost of business gifts you give directly or indirectly to each person during your tax year.
While this is just one example, knowing the specific rules around what is and isn’t deductible will help you budget accordingly.
And this is particularly important with the passing of the TCJA, which changed the rules about writing off expenses such as meals and entertainment.
6. Set Aside 30% For The Taxman
Though most people know they will need to pay business taxes, few first-time entrepreneurs actually prepare for taxes in advance.
The problem is, when tax time rolls around, some business owners find they don’t have enough cash on hand to cover what they owe.
Therefore, one of the best cash flow management strategies is to set aside money for all of the business taxes you’re obliged to pay—federal and otherwise—throughout the year.
As a general rule of thumb, you should be setting aside approximately 30% of what you earn to cover both federal and state taxes.
It’s always better to set aside a little more than you think you owe than to not set aside enough.
How you set aside this money is also important for bookkeeping purposes and will depend on what kind of business you’re running.
For first-time business owners, you won’t have a past tax return to help you estimate how much tax you’ll owe. In this case, the best saving method is to put 30% of each payment from a client or customer into a business savings account.
Putting this money away each time will give you a more accurate picture of your business finances and ensure you don’t spend money that should be going to the government.
7. Don’t Go It Alone
It takes a lot of guts to be an entrepreneur. But just because you’ve got what it takes to pursue something new, it doesn’t mean you can do it all on your own.
Perhaps one of the most difficult things for entrepreneurs to wrap their heads around is realizing that they need to rely on the expertise of others in order to make their business dreams a reality.
For instance, the average small business owner spends over 10 hours per month on bookkeeping alone. While that may not seem like all that much, when you think about all the other responsibilities that require an entrepreneur’s attention, 10 hours is quite a lot of time.
Handing your books over to your local bookkeeper or a bookkeeping firm could free up significant time each week for more pressing matters. And having a professional manage your books also means that you’ll have someone dedicated to keeping things organized and the IRS happy.
The same goes for tax planning.
While you could try the DIY route, an accounting professional will save you time and offer valuable expertise that only CPAs have.
Hiring an accountant early on—instead of waiting until tax season—will also ensure you’re taking the right steps throughout the year to lower your tax bill and keep your company compliant.
Editor’s Note: This article is part of the blog series Start Your Business brought to you by the marketing team at UniTel Voice, the virtual phone system priced and designed for startups and small business owners, and Katherine Pendrill with OpenDigits, a full-cycle bookkeeping solution for growing startups.
Disclaimer: While every reasonable effort was made to ensure that the above information is accurate, UniTel Voice, LLC. does not guarantee that this blog post is accurate and up-to-date. UniTel Voice, LLC does not accept responsibility for any loss, damage or legal action incurred by your company as a result of the information contained in this blog post.