Sarah is a Cosmetologist who works 60 hours a week, has appointments booked six weeks in advance and has no idea how much money she makes. She spends her cash receipts as she pleases, and deposits other payments into her personal checking account.
Roger, who runs his own Heating and Cooling business, has business debt and personal debt on the same credit cards and is constantly stressed about how to make those payments. He stays busy but is never sure how well his business is doing.
Can you identify with Sarah and Roger? If so, you can easily organize your business finances by taking some very simple steps. So could Sarah and Roger.
1. Open a business account.
While you are at it, apply for a debit card and a credit card to be used in conjunction with this account. I realize that for many of you this is a no brainer, but Sarah didn’t have a business account and Roger didn’t have a credit card earmarked specifically for business.
2. Keep the account clean.
What do I mean by clean? Always put all receipts into your business account and always pay all business expenses from that account. Never pay any personal expenses from your business account. No exceptions. This means that Sarah would always deposit all receipts (including cash) into her business account and Roger would never use that account to make payments on personal credit cards. If you keep your business account clean, it will not only do much of your bookkeeping for you, but will, at any given moment, give you a rough snapshot of how well your business is doing.
3. Pay yourself from the account.
Make a habit of paying yourself on a regular basis (try once or twice a month) with profits from the business account. By “paying yourself”, I mean transferring money from your business account to your personal account. Think of it like getting a pay check from an employer, only you are that employer.
4. Plan for taxes.
Open a separate account for taxes and, each time you are about to pay yourself, deposit a percentage (try 25% — or ask your tax accountant what percent he recommends) into that tax account. For example, if your have $800 profit, you should first deposit 25% ($200) into your tax account before paying yourself the remaining $600. When those quarterly tax payments come due, you will be glad you set that money aside.
5. Use some basic money software to categorize your expenditures.
Check the expenses portion of Schedule C for the categories the IRS will expect you to use, then make your expenses match those categories. If you choose not to give the software a try, you need to place all physical paid bills in envelopes labeled by category. Some typical categories are supplies, advertising, rent, and office expenses.
6. Don’t transfer all of the profits.
You will need to maintain a buffer amount in your business account to cover expenses on months when your income is down. The more unpredictable your income is, the greater this buffer amount needs to be. Start by leaving enough cushion to cover two months of expenses, then adjust accordingly as you become more confident of your cash flow.
As your business grows (especially if you begin to hire employees), you might consider incorporation and hiring a bookkeeper. When that time comes, the simple steps described in this article will give your business a strong foundation for that growth.
In the meantime, these steps will ensure that you manage your money. You will be glad you did.
Readers: what additional business bookkeeping tips do you recommend for those who are self employed?
Photo by ryanmshea