Is your House in order?
If you read last month’s Spotlight, you may recall I mentioned I was rooting around into the eight entrepreneurial blunders that keep us from reaching our full business potential.
Last month we talked about combating perfectionism, and this month it is all about money.
Cash flow can be a challenge for entrepreneurs, but before we even start bringing in the green stuff, it’s important to have a dedicated financial structure set up for your business. Keeping your business and personal finances separated is critical to having clean documentation – and making your CPA’s life a lot easier come tax time.
Back to the beginning. Once you decide to start a business, the first things you should do are:
- Register your business as a formal entity (likely an LLC) with your Secretary of State office.
- Obtain a dedicated EIN (Employee Identification Number), which will create a complete entity, so your business becomes its own little legal being.
- Once you have that in place, you can take all of your materials to the bank and open a bank account specifically for your business.
- Choose your method of distributing invoices or taking payments, and link it all to your business account. (For suggestions on payment gateways, check out February’s spotlight on my top tech for solopreneurs!)
Now you’ve established the groundwork for that separate financial foundation we want for your house (business).
I know what you’re thinking: I’m small; I do this on the side…I don’t need to go through all of these steps.
Setting up these is still not a huge undertaking. Not only does it provide the financial separation we want you to have when you’re in any kind of business, but it also provides a veil of protection and liability.
If you’re smaller and your cash flow is coming in as ebbs and flows, you can pay yourself through distributions that will be considered self-employed income at tax time. Simply transfer from one the business to the personal account with a memo “owner’s pay,” and it’ll be easy to track in your ledger.
However, once you start to get into consistent cash flow, you’re going to want to start thinking about converting your LLC to an S Corp.
As the owner of an S-Corp, you’re able to pay yourself as a W-2 employee, which you can’t do with an LLC. This means you can set up payroll with standard deductions that lower your tax risk and liability..
If you’re bringing in a salary’s worth of income into your business, it’s likely you’ve been smacked with a $7,000 bill come April 15th. That’s a clear indication it’s time to start cutting yourself a paycheck!
It’s also really empowering to set up payroll for yourself. Set it and forget about it!
If you’re well-established in business, I’ll add another suggestion. Think about setting up a Profit First system where you intentionally, and proactively, save money for the areas you know you’re going to need it.
I started following this framework, which is also a book by Mike Michalowicz I highly recommend. It was a game-changer (and a huge catalyst to buying our home in July!).
Here’s the gist of Profit First (follow it exactly or adapt it accordingly – this is meant for inspiration!)
I have several business bank accounts, five to be exact. This is obviously a little more structure than you need if you’re small, but if you’re full-time in business it’s an amazing way to control your finances.
First, Income Account – where all payment gateways are connected to, and all income is funneled.
From there, I allocate certain percentages out to different accounts for
- Operating Expenses
- My Compensation
- Taxes (talk about no surprises come tax day!).
- Finally, the fifth account is for profit.
I funnel about 10% of my monthly income into this account, so I have operating reserves when I want to execute a new initiative, or buy a house! 😉
Wherever you’re at in business, take stock of your financial situation and see where you can improve. You may feel like you’re a little too small to get into all of this, but when your business booms overnight, you’ll be really glad you had your house in order before you started building that second story.
Your Friend and Coach,