Since we work with many brand new startup companies, and since the finances of a startup and the finances of its owner are often intertwined, and since lack of cash flow and poor cash flow management is the number one reason small business fail we find it hard not to at last address personal finance when helping startups grow their businesses. Wow, that was along sentence. Here are a few pointers that we hope you heed.
Tax withholdings. This I believe is the most common trap of business owners and the self-employed.
Step One. Open two new checking accounts dedicated to your business.
Step Two. Deposit all revenue into one account and pay all expenses out of that same account.
Step Three. Of what’s left offer (profit) transfer 25% of it (tax withholdings) into the second business account. Use this to pay your quarterly tax estimates. Falling behind will cost you 10% penalty plus interest courtesy of the IRS. If you are a sole proprietor, an LLC or even and “S” Corporation your business income is passed along to you as the owner, so you are taxed at your normal tax rate. The business does not pay it’s own taxes as is the case with e “C” Corporation (35%). So the tax rate you pay will depend on your taxable income. Therefore the 25% mentioned above is meant as a guideline only to keep you from falling behind in your first year. In year two you can use your tax estimates from year one two increase or decrease that percentage taking into account current year profit.
Step Four. Pay yourself from the remaining 75% ONLY. You don’t have to pay yourself the whole 75% you’ll probably want to keep a percentage in “retained earnings” which is what you’ll use for future investments in the business.
Step Five. Never EVER use the business accounts for personal use and vice-versa. There are major audit implications but most importantly it’s harder for you to keep a handle on your business financial situation if you do. Easier said than done. Good organization requires a little bit of self discipline but so do a lot of things.
Debt. We recommend you have no debt when starting a business, and as a corollary we recommend you not GET into dept in order to start your own business. It’s hard enough at the beginning without extra payments each month. And to those who still think you need to borrow money to start a business, the Bureau of Labor Statistics reports that in 2011 most businesses, 68%, were started with less than $5000.
If you’ve started and you’re already in debt, you’re at a big disadvantage. And if your debt payments prevent you from effectively managing your cash flow, we recommend you put everything hold until the debt is paid.
Business Necessities and Personal Toys. Often personal luxuries are mislabeled as business necessities such as fancy stationary, expensive electronics, decadent furniture, prestigious locations. Here is a rule you can apply if you’re not sure something is a business necessity or a luxury. Something is a necessity if it is requirement to make a sale, produce and deliver a product or furnish a service. Everything thing else is by definition a luxury. That doesn’t mean a business can never own luxury items, just don’t delude yourself about which is which, and might we suggest hold off on luxuries until your business can reasonably afford them, if that’s not obvious already.
For a small upstart the line between personal finance and business accounting is fuzzy and inextricably linked. We believe a healthy business therefore includes healthy personal finance.