Dave Heistein
Look underneath the surface of any good business, and you’ll typically find finances that are well-managed and in order. This is why I wanted to invite my personal CPA, Dave Heistein from ProfitwiseAccounting.com, to write a guest post to talk about what we as entrepreneurs can do to best manage the finances of our business.
I’ve been working with Dave for over five years now, and he’s been fantastic. CPAs come in all styles, and I love working with Dave because he’s always very honest and he plays it safe for the benefit of my family and my business. Here he is with some tips to help you manage your own business finances, no matter what level you’re at right now.
Most of us would agree that highly successful people tend to share common traits such as tenacity, vision, hard work, luck, and business savvy. We often say these people, like Steve Jobs, Mark Cuban, and Bill Gates, have the “midas touch,” because they seem to have the aptitude for turning the majority of their business ventures into great successes.
We would also not be surprised to learn that these successful entrepreneurs have all become masters of managing their business and personal finances to a certain degree by virtue of their enormous success. People like Mark Cuban and Bill Gates have their own financial teams that oversee and make recommendations to them and to their businesses that ensures they are making the wisest financial moves and avoiding potential legal, accounting, and tax landmines and pitfalls.
As the managing partner of a small business accounting firm, I have worked with hundreds of entrepreneurs throughout the years. When it comes to managing business finances, not surprisingly, the tax and accounting elements of these businesses are typically not well understood. Additionally, most entrepreneurs don’t enjoy the administrative and finance side of their businesses and would rather focus their time and energy on developing their product or service, sales and marketing, and growing their businesses. As a result, the financial side of the business becomes severely neglected and can create unneeded legal, tax, and governmental compliant risk as well as undermining their own business success.
In my opinion, the best two strategies for becoming one’s own “master” of business finance are:
- To become a lifetime learner
- Surround yourself with a great advisory team
Core Strategy #1: Become a Lifetime Learner
Our clients who tend to be the most successful are continually absorbing new information, broadening their knowledge base by reading and attending seminars, as well as seeking consistent advice. Those who don’t do as well typically have an aversion to all things financial and tend to bury their heads in the sand and hope that the stars will all magically align for them someday.
Additionally, when it comes to their business, most of our successful clients are experts in their industry, and have a keen understanding of the key business drivers and points of difference that separate them from their competitors. For example, we have a successful daycare provider client who is opening up new locations throughout the US. I was amazed to learn that he researched over 100 different day care centers currently in operation and knew all the specific key profit drivers and points of difference needed to be successful in his business. That type of research and knowledge isn’t typical for most small business owners but it is what separates those just getting by with those who have achieved large success.
Core Strategy #2: Surround Yourself With a Great Team
The second core strategy is to surround yourself with a great team. I love the old saying, “What’s the difference between the CEO who makes $100k per year and the CEO who makes $1M per year? The CEO who makes $100k is a lot smarter.” Obviously a bit of tongue and cheek there, but the general concept is that $1M CEOs have been able to achieve leverage in their businesses by not trying to do everything themselves. Most small business entrepreneurs tend to be smart and have aptitude to do a lot of things. Sometimes they have a tendency to take on a “do it yourself” or “trading their own time for money” attitude, which in the beginning stages of a new business venture makes sense when cash is tight and you have more time than money. But as the business grows they need to quickly transition themselves into a delegator role where they can attain leverage and bring in new ideas from the outside experts in their respective fields, as well as leverage the work of others. Henry Ford was a great example of someone who was hugely successfully but also typically the “dumbest” person in the room when it came to the inner workings of an automobile. His key value add was interpreting the information provided, synthesizing it, and putting it into action in his business. The result: one of the most successful US automotive companies of all time.
As a CPA and a small business accounting services advisor, I have some some key tips that my firm and I provide our clients when it comes to becoming a successful “master” manager of your business finances:
1. Use the Proper Business Structure
While it is tempting to be a lone wolf when it comes to your business structure (incorporating, LLC, sole proprietorship, etc.), it’s important to resist the temptation and seek proper legal and accounting advice. When meeting with new clients, I have seen many instances where they incorporate for the wrong reason or they make improper assumptions.
The number one mistake I see is when business owners attempt to form an entity out-of-state and not in their home state (where they work and live), with the goal of avoiding state tax. It’s only later that they find out they have to register as a foreign entity in their home state and pay double the original fees, or they possibly scrap their out-of-state entity and form a new one in their home state to reduce future cost and filing complexity. Delaware, Nevada, and Wyoming can be seen as safe havens, but just be sure to educate yourself on the pros and cons before making the decision. Some businesses are able to save on state taxes by organizing in various states given the nature of their business and organization structure, but not all.
2. Don’t Delay Tax Planning
Proper tax planning and understanding of tax brackets is another area I often see not being done and not well understood by most new entrepreneurs. Perhaps second to buying a home, taxes are the largest expense most people will incur over their lifetime. Proper tax planning and tax reduction strategies in some cases can put immediate savings into one’s pocket, and can add up to a significant amount of potential savings over time.
It’s important not to delay with planning, because in many cases, once the end of the year passes, there are fewer options available. It’s also important to take into account one’s business entity structure, owner compensation, retirement, and fringe benefits when devising an overall tax strategy. Also, consider your current tax bracket as well as future anticipated brackets for coming up with timing strategies on years that you want to maximize deductions versus taking more income.
3. Set Up an Accounting System
When it comes to having good control over your business finances, a good accounting system is at the top of the list. There is a wide range of accounting systems and software solutions on the market. The size and nature of your business will help drive the decision as to what type of system you need. Here are the three accounting systems we see most small businesses use:
1. Manual Paper-Based
This is the old traditional system of using ledger and receipt books that you would typically purchase at any office supply store. For example, my gardener invoices us with a paper invoice book that contains carbon copies and keeps a paper notebook to summarize his income and expenses by month.
2. Manual Spreadsheet
Some may use Excel, Google Docs, or some other type of spreadsheet to summarize accounting data. While Excel, for example, can be a powerful tool in its own right, it’s typically not my first choice when it comes to selecting a good accounting system for a small business. If you have a very small or micro business, a spreadsheet method may be fine for you when you are just recording a handful of transactions over the course of the year.
3. Software or Cloud-Based
In my opinion, this is the best way to keep track of your business finances. Most of these systems allow for the downloading of accounting transactions, a way to consistently code your expenses, and produce meaningful reports that will provide you with information on how your business is performing and let you know if you are actually making any money.
A key feature I typically look for in these solutions is a checks and balances system to make sure you aren’t making any serious errors in your input. For example, reconciling your bank and credit card accounts is critical to make sure your input is correct. While not all have this feature, a double entry-based accounting system is essential to make sure your debits equal your credits. Without these two important features, it’s very possible you could be relying on incorrect financial info and not even realize it.
Here are my personal recommendations for software and cloud-based solutions in order of preference:
[Full Disclosure: As an affiliate, I receive compensation if you purchase through these links.]
QuickBooks Desktop or QuickBooks Online
Pros: Choice for most small businesses, many features
Cons: Lack of integration with the desktop version; technology quirks, and lack of speed with the online version
Xero
Pros: Built from the cloud up, lots of integration options
Cons: Interface, poor month-end reconciliation feature
Freshbooks
Pros: Strong on invoicing and time tracking
Cons: Not a true double entry accounting system
Wave Accounting
Pros: Free solution, good for micro businesses
Cons: Not a true double entry accounting system
Proper accounting system setup is critical. You know the old saying, “Garbage in equals garbage out.” As you can probably imagine, as an accounting firm and bookkeeping advisor we spend a lot of time unraveling the messes many small business owners have created by just haphazardly entering information when they first come to us. In some cases it’s more cost effective to scrap their entire accounting file and start over from scratch. So again, if you aren’t highly confident in your accounting system set up, a few hours of professional advice could pay huge dividends in the future. If you or your staff are doing the data entry in your system, make sure you have it professionally reviewed periodically. Again, you don’t want to base important business decisions on flawed financial data.
4. Create Separation
As soon as it’s feasible, I always recommend separating your business accounts from your personal accounts. If you are incorporated, you will need to set up a separate business bank account in your business name and the Employer Identification Number (EIN) issued to the business. I’ve seen cases where people have forgotten to do this and instead use their old sole proprietor bank accounts and think they are still acting like a corporation. Just because you incorporate doesn’t automatically mean you get all the advantages of being incorporated.
In the industry they call this “observing corporate formalities.” That means you need to do things required by state and federal law to actually be considered a properly formed and operating corporation. For example, if you use the corporate bank account as your personal and business account, then what you are doing is commingling business and personal expenses. By doing this it makes it easier for someone to pierce your “corporate veil,” which is your legal protection. Doing this also diminishes your credibility with the IRS or state in the event of an audit. If a federal or state agency discovers you are commingling expenses in the same account, they could disallow many of your legitimate businesses expense deductions if you didn’t keep proper documentation.
Regardless of whether you are incorporated or not, I typically recommend the following accounts in the business name only:
- Business Checking and Savings (this includes Paypal, Amazon, and Ebay, or other online accounts you may have)
- Credit Card Account
You should also maintain separate bank and credit card accounts for your personal expenses, bills, etc. When you go out to make a purchase, figure out what card you should use. If it is a business or personal expense, use the appropriate account or card.
Another benefit of creating separate accounts for personal and business is that it will make it much easier to determine what is business and what is personal. You’ll then want to make sure all your business accounts are set up in your accounting system. If your financial institution allows you to download your transactions into your accounting software, say QuickBooks Online, you are halfway to getting your transactions where they need to be. The next step will be to create categorization or coding of those transactions as well as making any necessary monthly journal entries or adjustments.
5. Capture All Reimbursements
From time to time you will either be in a situation where you paid for a business expense by mistake with a personal credit card or bank account, or perhaps your business didn’t have available funds so you needed to make purchases from your personal accounts. In order to capture all of your reimbursements, ensure you get reimbursed by your business, or at least get “credit” for these expenses. You have two options for handling this.
- Create a monthly expense report. This is just like what you would do if you were employed by any company that would reimburse you for your monthly expenses. You would fill out a report, attach copies of your receipts, and submit it for your payment.
- Two online solutions we like for helping to automate the expense report process are www.expensify.com and www.receipt-bank.com.
6. Track Vehicle Mileage
In the event of an audit by the IRS, in most cases you will need to produce some type of mileage log proving to the IRS that you can legally deduct mileage for your business vehicle. It’s true that in some cases, with special types of vehicles and fleet vehicles, mileage tracking isn’t required. Although typically this isn’t the norm, and the vast majority of small business owners should be tracking mileage to substantiate their vehicle deduction regardless of whether they take the actual expense versus the mileage method of deducting expenses. The most common methods for tracking mileage are:
1. Brute Force Method
This is where you record beginning and ending odometer readings every day, and log your business trips and personal miles driven during the day. The total of your business miles for the entire year would allow you to determine your total business miles multiplied by the standard mileage rate; or if you are deducting actual business expenses, it will help you arrive at a percent of business use based on total business miles in relation to total miles. For example, if you drove 8,000 business miles and had 10,000 miles in total, your business use percent would be 80 percent. If you spent $10,000 in actual auto expenses during the year (gas, repairs, license, registration, loan interest, depreciation, etc), you would be able to deduct $8,000 in vehicle expenses for that tax year.
2. Allocation Method
This is our recommended method if your business driving is fairly uniform throughout the year. With this method you would use the Brute Force Method for three months out of the year to create an historic sampling. If your business use was 80 percent, you could apply 80 percent for the entire year and not have to worry about tracking mileage the entire year, which could potentially save you a lot of time.
Additionally, in recent years smartphone apps have gained popularity as mileage trackers. MileIQ.com is a GPS enabled smartphone app that we hear a lot of positive client feedback on.
7. Maintain Document Files
Another major challenge most entrepreneurs have is dealing with the varied paperwork, receipts, invoices, and bills generated in their business. We’ve all heard of the old story, a shoebox full of receipts dropped on the accountant’s desk at the end of the year used to reconstruct the books for the entire year. In my opinion, this is nobody’s favorite way of managing business finances. There are three general ways I see people managing their business paperwork.
1. Manual paper filing system
This is the old school way of keeping everything in manilla folders and a filing cabinet. There are numerous ways of filing and organizing information based on the size of your business. For example, a larger business might have a filing cabinet designated for their vendors, each vendor would have their own folder and they would file the bills in those folders once paid. For smaller businesses, having a folder for all receipts and invoices by month or year may be sufficient. A lot of possibilities exist when it comes to one filing system over another.
The number one rule is to create a system that allows you to easily retrieve a piece of information if needed. My personal favorite for smaller businesses is to create a folder for each account. So each business account would have its own folder, every month the bank statement would go in the folder, followed by all deposits with supporting invoices and deposit slips, followed by all vendor invoices or receipts paid out of the account. What I like about this method is, if you know the specific month a transaction occurred, you can locate the information. If you are using an accounting system, you search on the transaction to locate the date and account, and easily reference the information in your paper file. Also, in the event of an IRS audit, it makes it easy for the auditor to see if you have the adequate backup for those transactions by reviewing your bank and credit card statements.
2. Computer or Cloud based system
If you have a desktop computer or a traditional computer network, you could have a filing system similar to a paper-based one but you would replicate the organization and folder structure on your computer’s file system. We also see a lot of entrepreneurs using Google Docs, Dropbox, and other solutions. The benefit of the cloud-based system is that your information is automatically backed up and it’s much easier to share this information with others if needed.
Additionally, there are other solutions that take the concept of Dropbox to the next level. Hubdoc.com is a great solution if you’re looking for a central hub for your bank statements, receipts, bills, etc. Hubdoc can login into many vendor (e.g., AT&T, Verizon, Amazon, etc.) websites and pull down PDF copies of bills. It will also sync with accounting systems, such QuickBooks Online and Xero, and attach the receipt to the actual transaction in your books. Eventually, I think having all receipts and transactions automatically linked to the accounting transaction in your company books is the way of the future. This helps by making it easy to look up information, or in the event of an audit, the auditor could just click on the specific transaction and see the backup right there on the screen without having to go digging through boxes of receipts.
3. Hybrid Approach (of both paper, computer or cloud)
I would guess that most small businesses that are making the move to method two above still find themselves in a hybrid situation of saving some information online and the rest in paper files. I would recommend, if practical, stick with one method as much as possible to create a standardized system of accessing information.
8. Audit-Proof Your Business
One of the goals for any business owner should be to audit-proof their business as much as possible. There are numerous factors in determining if a business is at risk for an audit. Your entity structure, gross revenue, profit, deductions, and industry all play a role in determining if you win the audit lottery. Also, sometimes it’s just dumb luck that determines an audit over any specific factors.
It’s important to understand that there are different types of audits and different agencies that conduct audits for different reasons. For example, when most people think of an audit they think of an IRS audit. But you could also have an audit from your state for income tax, employment tax, sales tax or labor, or other type of issue depending upon where you operate your business and the industry you are in.
To successfully survive the audit, you want to make sure you understand the rules and follow them accurately. Many times I see small business owners unaware of certain requirements and, as a result, waste hard-earned dollars they didn’t have to pay. For example, I met with a new prospect who had just completed a sales tax audit. He was unaware that he also needed to collect sales tax from his other online sales channels and failed to ever collect state sales tax on those sales. As a result of his audit, he had to pay back thousands of dollars in back taxes, penalties, and interest. He could have easily avoided this unpleasant situation if he was aware of the rules and had sought proper advice instead of doing so after the fact.
Secondly, doing well in an audit will come down to evidence or proof you can provide, just like if you were going to court. Proof for small businesses comes in the form of records such as invoices, receipts, and accounting documents. Knowing what papers to retain and for how long is critical in successfully audit-proofing your business.
9. Avoid Procrastination
This is probably the biggest issue that most entrepreneurs have when it comes to successfully managing their finances. I recommend setting aside a specific day or time each week to address any important financial issues in your business. From time to time, we bring on new clients who haven’t maintained their books or filed tax returns for several years. As you can imagine, it’s sometimes a large undertaking to get current and can be a somewhat painful process. Maintaining your finances is a lot like losing weight. It’s much easier to go to the gym during the week and cut out on the occasional overindulgence than it is to go on a three-month crash diet that you may or may not even be able to complete.
I congratulate you for having the courage to be an entrepreneur or for at least evaluating the possibility of going down this path if you haven’t made the leap yet. Gaining a grasp of proper financial management will be a lifelong skill that will serve you well throughout your entire business and personal life.
Here’s to your continued success.
Pat Flynn
Richard A. Chapo
