As one of the most overlooked aspect of starting a new business, accounting (or lack thereof) can be a major headache for startup founders and small business owners. This ‘New Business Accounting Checklist’ will touch on the six most crucial areas you need to know about. All of these areas are topics that come up time and time again as I speak to both new and seasoned entrepreneurs. First, it is important to consider the tax implications of your business’ legal entity type. Second, it is crucial to establish a separate bank account dedicated to your business activities. Third, it is critical that you have some method of bookkeeping from the start, so you are organized come tax time (at a minimum). Fourth, establishing a baseline budget, forecasting into the future and analyzing variances on a regular basis will help you keep a pulse on your business and avoid any unexpected surprises. Fifth, it is paramount that you understand how you should go about paying yourself for all your hard work, as well as any employees or contractors you hire to perform work for the business. Lastly, (but certainly not least), it is of utmost importance that you accurately understand and comply with all necessary tax obligations on a timely basis. We will explore these areas in detail as we break down the different components of the ‘New Business Accounting Checklist.’
Entity Type Matters
Far too often, new entrepreneurs will race to incorporate a newly launched startup based off incomplete information, ultimately incurring unnecessary fees to repeal a previous entity election. There are pros and cons of each type of entity that you elect, and you should consider each one in detail as you make your decision. The entity types are categorized into two different buckets from a tax perspective– flow through entities, and separately taxed entities. Sole Proprietorships, Partnerships and LLCs all have “flow through” tax treatments, which means that income earned by the entity ultimately flows through to the owner’s personal tax returns. For a C-Corporation, earnings are taxed at the entity level as well as the individual ownership level (should the C-Corp distribute dividends). This effectively double taxes the earnings of a C-Corp, since earnings are taxed at the entity and individual level. Another entity choice, the S-Corp, is actually a tax treatment of either a C-Corp or an LLC that is made by filing Form 2553 with the IRS. An S-Corp is still a flow through entity, but it provides opportunity for an often powerful tax strategy by avoiding self-employment taxes on a portion of your income.
The entity choice is one that should be carefully considered, both from a legal and tax standpoint. Be sure to consult your CPA before diving headfirst into an entity choice. A skilled Accountant will be able to identify your long term goals, and make the proper recommendation for you.
Establish a Business Checking Account
Speak with any attorney on the topic, and they will emphasize the legal ramifications of co-mingling funds, specifically that it is a huge no-no. While this is certainly true, there are also accounting reasons behind why this is so important. First, in the event of an IRS audit, having your personal funds and business funds co-mingled could put you in a disadvantageous position in defending the deductions you are claiming. It is best to have clear and separate banking activities to avoid any additional and unneeded scrutiny. Establishing a separate business bank account also makes bookkeeping easier, and more powerful. Not having to manually add in transactions from personal funds makes bookkeeping less complicated, and makes it easier to ensure completeness of your financial records (you don’t have to worry about missing any transactions after doing your bank reconciliations). It also enables you to quickly and easily generate financial reports for strategic decision making.
Establish a Bookkeeping System
Bookkeeping is the systematic collection, analyzing and recording of source documentation to ultimately produce financial reports. The most popular source of source documents is a business banking account. However, bookkeeping differs from a banking account in that it tells a story of the business’ performance over time in the form of financial reports. For example, a bank statement will show an opening and ending balance– which is fine in analyzing cash balances, but it lacks the information to explain the activities behind the change in cash balance.
Setting up a bookkeeping system doesn’t have to be overly complicated, and there are many different software platforms out there for every budget. Industry leaders like Quickbooks Online and Xero provide cloud based options, while smaller players like WaveApps provide a free (albeit limited) bookkeeping platform. If you are unsure of how to set up a bookkeeping platform, be sure to consult an expert on laying the foundation for sound bookkeeping from the start.
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Prepare a Budget & Forecast
A budget is a representation of estimated income and expenses for a given period of time. A forecast will typically take that a step further, and attempt to project income and expenses throughout some period of time in the future. Oftentimes, a budget is the course the business wants to take, whereas a forecast is a more updated and timely representation of where the business is actually headed based off assumptions. Budgeting & Forecasting is crucial to helping plan your business and can often help identify troubling trends before it is too late. Further, establishing a budget & forecast will enable a business to understand it’s burn rate and remaining runway, which are both useful metrics for startups and small businesses. Essentially, without establishing and regularly analyzing your budget & forecast, you are flying your business blindly.
Know How to Pay Yourself & Employees
Perhaps the most overlooked area for founders and small business owners, it is important to understand that how you pay yourself and employees is critically important. How you pay yourself as an owner depends largely upon your legal entity type, and often isn’t as simple as cutting yourself a check from the business bank account. Make sure you understand any and all compliance requirements before paying yourself for all your hard work. In addition, paying employees isn’t always straightforward. You first have to make a determination of whether or not the person performing the work should be treated as a W2 Employee or a 1099 Contractor. Both have their separate and distinct tax filing requirements, and have drawn increased scrutiny from the IRS recently. Speak with your CPA to help understand the IRS 20 Factor Test and any necessary filing requirements with respect to hiring and paying your labor force.
Understand & Comply with your Tax Obligations
Death and taxes are the only two guarantees in life. Despite this, many small business owners and startup founders fail to properly understand their tax requirements, don’t make the necessary tax filings & payments, or both. Sales taxes are often a compliance nightmare for small businesses and startups, and can lead to disastrous consequences if not handled properly. In addition, estimated tax payments are often treated as an afterthought for entrepreneurs, and can lead to nasty surprises come tax time. It is also important to understand the self-employment tax requirements for the self employed, and how this additional 15.3% impacts your bottom line is often an unwelcome surprise for small business owners and startup founders. Finally, there are countless deductions and tax credit that may apply to your business, and having the right CPA on your team can help you pro actively identify tax savings opportunities.
By no means is this a comprehensive list of every accounting related topic small business owners and founders may encounter, but each and every one of these points is something that should be carefully discussed in detail with your CPA. If your Accountant isn’t able to provide actionable recommendations in each one of these areas, schedule some time with us and we’ll help make sure you get off on the right foot in your entrepreneurial journey.
Need Help? Schedule a FREE consultation with a CPA!