Updated: Apr 29, 2021
So you decided to take the plunge into entrepreneurship, congratulations! While this is an exciting and thrilling time, there are so many ‘behind the scenes’ tasks that usually get overlooked. This post aims to clear the air on the tedious financial aspects so you can spend less time on the administrative side and more on your business.
Open a Bank Account
The first and most important item I tell all entrepreneurs to do, no matter how big, small, new or old their company is: Separate your business from personal expenses. Even if you are just starting out, having a separate bank account, debit and credit card will save you headaches down the road. I can tell you from experience that itemizing months of transactions to declare business vs personal expenses is a tedious, hair pulling exercise.
The steps to opening a business bank account are quick and easy if you follow these steps:
Incorporate your business with your State. In Colorado, you can use the Colorado Secretary of State website. If you have a business name, you'll first want to check and make sure that name is not already registered by doing a quick search on the Business Database Search. If it is available, you can then register your business by Filing a New Form with the State. You will need to choose the correct business organization type, such as LLC, Corporation, or Non-Profit. The price to do this varies on which State you are located in and your business structure type. For LLCs in Colorado, the fee is $50.
Obtain an EIN for your business. They are free and quick to obtain. An EIN is like a social security number for your business. It allows the government to identify your business from a tax perspective.
To open a business bank account, you need both a registered business and an EIN number. Once you have these, you can run over to your bank and have them open your account.
When opening a business bank account, you want to find a bank that doesn't charge monthly fees. When you start out, every dollar counts, and wasting those precious dollars on monthly account maintenance fees is easily avoidable. You will also have the option to be issued a debit card and possibly a credit card. As long as it is fully paid off monthly, a credit card will help establish a good credit standing within your business, making it easier to get more credit or loans in the future.
It is realistic to complete all of this in half a day or less, with most of that time being spent at the bank. Registering your business and obtaining an EIN can be done in less than an hour!
Depending on your business structure, it is possible to operate your business and provide reliable tax documentation with mixed business and personal transactions. While this may be acceptable from a government standpoint, it is very tough to understand how your company operates. Determining your actual business expenses and profitability with mixed accounts is near impossible. Further, if you ever wanted to put together a budget, a common method is to utilize your historical data. If that data includes your personal spending, all of your business history is essentially a waste. To utilize that historical data brings us back to the beginning of the post, where you'll have to go through that agonizing, hair pulling, itemization exercise! Understanding your financial health, profitability and using your historical data is crucial and setting that up from day 1 starts you on the fast track to financial success.
Owner Draw or Payroll?
When the day comes that you can pay yourself for all of your hard work, it is a great feeling! However, you cannot necessarily just transfer money from your business to your personal account. Depending on your business structure, there are requirements of how you must pay yourself:
If you operate one of the following, then you must pay yourself an Owner Draw:
An owner draw is a simple transfer of money from your business account to your personal. This payment is recorded on the Equity section of your Balance Sheet. An owner draw is not a business expense and therefore is not deductible, nor does it affect your business’s Net Profit.
If you operate one of the following, then you must be on the payroll as a W-2 employee:
Keep in mind that an S-Corp is also an LLC form (not to be confused with the paragraph above). Even if you are a one - (wo)man show, you are taxed differently as a corporation. Setting up payroll may sound intimidating, but utilizing QuickBooks Payroll or Patriot Software, which integrates to Quickbooks, makes the process easy. They even file and pay your taxes for you.
In an S-Corp, you can also take a distribution, which is essentially equivalent to an Owner Draw, but the catch is that you cannot replace your W-2 income with your distributions.
In a C-Corp, as the owner, you must also be a W-2 employee and have the option to take dividends as an extra form of payment. C-Corps become much more complicated, and if you are structured in this way, it is worth discussing with your CPA to determine the best and most tax-advantageous way to pay yourself appropriately.
Your payroll wages and taxes are classified as a business expense and are found on your income statement in the corporation structure. These expenses will reduce your Net Profit. There is a point where changing from an LLC to an S-Corp has tax advantages from a payroll perspective. Talking with your CPA to make this switch at the right time is beneficial and can save you money in the long run.
Saving for Tax
The last item that gets commonly overlooked is saving for taxes. It is easy to look at your Income Statement and see a nice profit. Chances are, you’ve already spent the money that is showing as profit to your business. Whether you have loans or you’re taking an owner draw, that ‘Profit’ tends to disappear quickly.
Then Tax time comes around!
Suddenly, you have to come up with the cash to cover your tax bill, and you are pinching pennies. In my experience, this is one of the quickest and easiest ways for businesses to go out of business.
A great rule of thumb is to save or earmark 15% of your Top-Line Revenue or 30-35% of your Net profit and set it aside for taxes. That way, when Uncle Sam comes knocking, you can hand him a check, and you are always confident you'll have enough to cover your taxes. Again, this is a rule of thumb, and each scenario is different, so having this discussion with your CPA is vital in making sure you are adequately prepared for your taxes.
This article does not offer tax advice, and you should seek out a qualified CPA for any tax advice.