Where to Start When Setting Up a Small Business
Part 2: The Money Flow
In Part 1, we looked at the basics of setting up a business, selecting the tax structure, establishing a bank account, and how to start tracking your income and expenses. Now it’s time to dive a little deeper and look at how money flows through your business and what you might need to do to be sure it works to your best advantage.
Step 1: Understand Expenses and Income for Your Type of Business
Every business has its own set of expenses and sources of income. It’s a good idea to make of list of what these may be before they come. This will help you to do proper planning and budgeting and also help you track the overall health of your business as time goes on.
- Do you have equipment rentals or special insurances?
- Will you have employees or sub-contractors?
- Are there material costs for products you create or shipping costs?
- Will you need to draw funds from the business for your own personal use?
- Will you be purchasing equipment or vehicles to use in the business?
- What about general and office supplies, advertising, promotion, rent, credit card processing fees and loan payments, just to name a few?
- How many payment methods are available to your clients or customers?
- Will you receive refunds for unsold goods or unused products?
- Will you receive deposits on work prior to fulfilling an order?
- Will you need to progress bill your customers for large projects?
Reviewing this list of income and expenses will help your accounting professional or tax preparer advise you on tax benefits of which you may be able to take advantage.
Step 2: Track Your Mileage
This is a small item that quickly adds up. Track all your mileage, wherever you go. It’s important to track not just when you’re driving for business-related reasons, but at all times. This way, there is strong evidence for the percentage of your automotive expenses reported to the IRS as a business expense. Without this proper tracking, the IRS could invalidate some, or all, of your claim for these expenses.
You can track your mileage fairly easily with a little notebook in your vehicle. Or, for those of you who love using your smartphones, there are also apps that will do this tracking for you via GPS. Check out my video where I talk about good apps for mileage here.
Step 3: Understand What Makes a Legitimate Business Expense
One of the biggest mistakes a new business owner can make is to claim something as an expense on their taxes that is not legally allowed to be used as a business expense. Audits do happen, and if the audit shows that you’ve deducted items that are not allowed, the amount due to the IRS may be significant and could include penalties and interest. Ignorance of the tax code is not accepted as an excuse.
This also brings up another issue. Sometimes you’ll claim a legitimate business expense, but you don’t have it formally documented. Remember: if you can’t show paperwork proving an expense, then the IRS may not accept it as a deduction on your tax return.
Don’t count on other business owners to tell you what is a legitimate business expense. Ask your experienced bookkeeper or accountant. If you aren’t sure at the time, document it and make a note to ask about it at tax time.
HOT TIP: Create a file folder marked ASK MY ACCOUNTANT and keep all questionable receipts and notes about issues in this folder for ease in finding when you have a meeting with your accountant or tax person.
Step 4: Decide How You’ll Let People Pay You
Will you be running a cash-only business?
Will you allow checks or credit card payments?
Will you process debit cards or receive payment through PayPal?
Each of these payment sources comes with their own set of challenges, expenses, and a certain amount of work to set up. Even running a cash-only business will mean some extra procedures be put in place to make sure income and expenses are accounted for properly and to ensure proper handling of cash (i.e. to make sure cash doesn’t disappear).
The key is to make these decisions as early as possible, so you can plan not only for the associated expenses, but also processing delays and all the fees that go with the payment methods you’ve decided to use.
Step 5: Prepare for Tax Collection
Will you need to collect and pay sales tax? This is not as straightforward a question as you might think. Sales tax laws vary from state to state and even from city to city and county to county. The sales tax regulations for an area also often change from year to year. You don’t want to be collecting taxes from your customers if you shouldn’t be. On the flipside, some people think they’re exempt from collecting sales tax when they’re not, so it’s worth double-checking with your bookkeeper, accountant or looking up the regulations for your area online. Just remember, the rules and guidelines can often be convoluted – so if you have any doubts at all, be sure to get in touch with an experienced professional.
In addition to sales tax, there are several other taxes you need to account for depending on where you live and what type of business you run. These can be either state or federal taxes, and often you’re expected to register ahead of time to make sure these taxes are paid properly and on time.
Going into the details on which taxes you need to collect in your specific case is a bit beyond the scope of this article, but it’s something that’s worth bringing up to an experienced professional so that you are properly prepared and informed. Want to have a chat to talk this through? Shoot me an email to firstname.lastname@example.org.
That’s a quick overview of the ways money moves in and out of your business. In the third and final part, we’ll cover payroll along with the final decisions you need to make regarding the bookkeeping for your business.
As always, I would love your comments and questions below!