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
{ 6 comments… read them below or add one }
Also, spending just 15 minutes a day on your finances / budget will save hours and hours (maybe even days?) of frustration when tax time comes around either annually or each quarter. Keep separate file folders for receipts: one for personal (the receipts you need to keep for big ticket purchases that might break), one for business (all expense receipts).
Out of all those tips – #6 has to be the most important. As a small business owner, we are always tempted to transfer all the profits to our personal account – to pay off personal debt, save for that vacation, etc. The problem is that, as a self employed business owner, we need to realize that revenue can easily fluctuate and therefore a cushion is the most responsible way to run a business. This will protect both the business as well as your responsibility to have enough money to pay your personal bills.
Be responsible and plan ahead for success.
Great tips…keeping up with your finances on a daily basis will help come tax season too. I do taxes for a lot of small businesses and self employed and every year there are a few who are surprised they have to pay so much taxes and do not put away the 25% (I put aside and recommend 30%…just to be safe).
Also a huge item is keeping your business and personal finances separate as you pointed out here. This really keeps things clean and less confusing. Good stuff.
@Matt,
15 minutes a day would be great, but 15 minutes a week would be more time than many take. It seems that people are good at their craft while not being good at tracking the money they are making. I like the file folder idea!
@Tyson,
It is good to hear from someone who does taxes…and I am not surprised that many of your clients are shocked by how much they must pay in taxes.
Other readers: are you listening to Tyler? Maybe you should set aside 30%, just to be safe.
This is really good advice. The first year that I was self-employed I had a lesson of hard knocks when it came time to pay my taxes. I hadn’t saved for it at all. I am much better at saving for tax time but I could do much better and be consistent in saving that 25%. Thanks for the reminder!
Mortgage,
I don’t have any statistics, but my guess is that many, if not most self-employed people start out with no concept of setting aside money for taxes. I am glad to hear that you are getting this issue under control in your business.