Whether it’s turning that pet grooming side hustle into a full-time gig or 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 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 getting burned, we’ve rounded up seven essential financial management tips that every entrepreneur should know before choosing their business name.
1. Never Mix Business With Pleasure
Regarding 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 need to buy ink for both your office and home printer.
It might seem easier for most people to put everything on one card and 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 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 requires 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 record your income and deductions properly.
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 coming out of your personal bank account, you may be giving the IRS the impression that your business is a hobby.
If you get audited, you’ll have difficulty convincing the IRS that you’re operating a business and that your deductions are legitimate.
2. Start With The Proper Accounting Method
When running a small business, it’s not just tracking money coming in and 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. If you bill someone for a project, you 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 earned, and expenses are recognized when a bill comes in. If you’re hired for a project, you will record the income as soon as the work is completed—even if the client has not paid you yet. You would also record expenses as soon as each bill arrives.
Choosing whether to use cash or accrual-based accounting affects your bookkeeping because it changes how you make day-to-day financial decisions and budget for the future.
While each accounting method has 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 pay them.
Regardless of which method you choose, it’s important to stay consistent to maintain accurate financial records.
3. Digitize Those Receipts
Even if this is your first business venture, you probably know 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 that many business owners don’t have a system 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.
These apps allow you to scan physical receipts and create digital copies using your phone. 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, 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 search your app for a digital record.
4. Think Like A Lawyer
While starting a business, quite a few bureaucratic hurdles may require you to navigate the legal system. However, few entrepreneurs consider the legal structure of their business before starting.
This is a problem because your business’s legal structure affects how you file your taxes and 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)
- Partnerships
- 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, so 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 to claim business deductions. However, what’s even more important is knowing what you can and cannot deduct before spending the money.
If you’re new to small business ownership, a “tax write-off” is a business expense you can deduct from your taxable income.
Essentially, these write-offs allow you to pay a smaller tax bill if 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 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 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.
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 must pay business taxes, few first-time entrepreneurs prepare for taxes in advance.
The problem is that when tax time rolls around, some business owners don’t have enough cash to cover what they owe.
Therefore, one of the best cash flow management strategies is to set aside money for all the business taxes you must pay — federal and otherwise — throughout the year.
As a general rule of thumb, you should set aside approximately 30% of what you earn to cover federal and state taxes.
It’s always better to set aside a little more than you think you owe than not to 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 go to the government.
7. Don’t Go It Alone
It takes a lot of guts to be an entrepreneur. But just because you have what it takes to pursue something new doesn’t mean you can do it alone.
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 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 take 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, the virtual phone system priced and designed for startups and small business owners.
Disclaimer: While every reasonable effort was made to ensure the above information is accurate, we can not guarantee that this blog post is accurate and up-to-date. We do not accept responsibility for any loss, damage or legal action incurred by your company due to the information contained in this blog post.
