Starting a new small business can be exciting, especially when it is a business venture that you enjoy. While running a new small business can be exciting, it can also be stressful when important steps are skipped over as the business is being formed. There are a several books and articles that provide step by step advice on how to legally create a small business. So why do many small businesses fail 2-5 years after being formed? The answers to this question are many, but the main answer for most businesses is that the owners skimmed over, or maybe entirely skipped over, some basic important steps of forming a business.
This article highlights five major steps every small business owner should familiarize themselves with as they form their business.
1. Understand The Basics of Business Finances
For many people, the thought of understanding accounting and deciphering financial data causes instant chills; and that is understandable. That is also where accountants and accounting businesses, like NaRfula Financial Solutions, come in. Though it is helpful to hire an accountant to guarantee your business’ financial health is in check, it is important that as a business owner you understand the fundamental principles of financial data. Three fundamentals business owners should familiarize themselves with are:
Analyzing financial statements
The 3 main financial statements business owners need to be able to analyze are:
- Balance Sheet statement – reflects business assets and liabilities
- Income (or, Profit & Loss) statement – reflects business income and expenses
- Cash flow statement – reflects business inflows and outflows of cash movement
Understanding what the data on each statement means is important as it impacts the business decisions made. A future article will explain these statements in detail.
Separating business financial activity from personal financial activity
This is a business fundamental that gets looked over by many business owners. When a business’ transactions (expenses and income) are mixed with the owner’s personal transactions it complicates the business in a number of ways. For example:
- It violates the economic entity principle of accounting. The principle explains that a business should maintain separate transactions from its owner’s transactions.
- It complicates audits and tax preparation work. The CPA, in order to properly perform an audit or file a tax return, will need to go through every transaction on the books to determine which transactions are business-related versus transactions that are personal in nature.
- It makes it difficult to assess how the business is performing. When business and personal expenses are mixed in with, a business may look and its financial statements and assume they are losing money because the expenses reflected are higher than they actually are. The reverse is possible too; a business may assume they are making a profit when they are actually losing money. This is caused by the financial statements reflecting a higher income than the actual income. The higher income reflected is a result of personal income being mixed in with business income.
One way of segregating business transactions from personal transactions is having separate bank accounts for each. Another way to segregate the two is by setting up separate chart of accounts in the accounting system. A CPA (or an accountant) should be able to assist with this task.
Having a general understanding of business taxes
A third fundamental every business owner should know is the basics about which taxes (federal, state, and local) the business is required to file, and the frequency for each filing requirement. While it is helpful to have a CPA or tax accountant file the business’ taxes, it is the responsibility of the business owner to make sure the filing is handled properly and by the specified deadline(s).
The 5 common federal tax categories for small businesses are:
- Income taxes – taxes imposed on the business’ annual income
- Self-employment taxes – taxes imposed on the owner’s pay received
- Estimated tax – taxes imposed and owed by the business quarterly
- Employer taxes – taxes imposed on an employer on income paid to employees
- Excise taxes – taxes imposed on specific products sold. For example, fuel and tobacco
The 2 common state tax categories for small businesses are:
- Income taxes – taxes imposed on the business’ annual income
- Employment taxes – taxes imposed on an employer on income paid to employees
Tax accounting can get complicated and confusing as the laws are constantly being revised and changed. Likewise, different states apply different tax rules, which can also complicate tax accounting. It is best to seek the help of a tax accountant or CPA to assist with business tax filings. If you need CPA assistance in this area, please contact our office and we would be happy to assist you.
2. Hire Professional Help
For most businesses starting out, funds are limited. This makes it easier to decide to skip hiring professionals and rely on the internet for help; this is not a good option. Such decisions have costed business owners their businesses over the years. Two professionals that every business owner needs to budget for and hire at the inception of her business are a CPA (or experienced accountant) and general counsel (lawyer). Why these 2 professionals? Accountants handle the financial pillar – life – of the business while lawyers handle the legal pillar –soundness – of the business.
A few of the essential services that accountants and lawyers provide a business are:
- Accounting records maintenance
- Tax planning, tax filing, and IRS representation on tax matters
- Audit planning and audit/assurance services
- Cash, budgeting, forecasting, and risk management services
- Consulting services, including:
- Setting up a new entity
- Litigation services
If your business is in need of CPA (accountant) services, please reach out to our office, we would be happy to assist you in this area.
3. Get General Liability Insurance
General liability insurance is also known as business liability insurance. This is insurance that covers your business; in a similar way that health insurance covers an individual’s health. Every business owner hopes she will never need to use liability insurance, but it provides peace of mind for the owner knowing that if her business ever needed it, it was available.
Most general liability insurance policies cover:
- Bodily damage (not employee injuries, that is covered by workers’ compensation)
- Property damage
- Reputational damage
- Copyright infringement
The cost of the insurance is determined by the amount of insurance a business needs. Before signing an insurance policy, read through the entire policy and make sure it includes everything you need for your particular business. If you need help understanding the policy, contact your lawyer or CPA. Remember that NaRfula Financial is here to assist you.
4. Get Workers’ Compensation Coverage
Any small business that has at least one employee should purchase workers’ compensation coverage. Workers’ compensation insurance is an employee benefit that covers a business’ employee if she incurs a work-related injury. Most policies cover:
- Medical care
- Funeral costs (in the case of loss of life)
- Disability benefits
- Wage replacement; if recovery time from work is required
- Legal costs
Workers’ compensation policies are overseen by state laws. Therefore, when purchasing a policy, a business should contact a lawyer in its state who knows workers’ compensation laws for that particular state.
5. Create A Business Plan
A business plan is the strategic plan of a business. It outlines the business’ goals, objectives, and how both of these will be met by the business. A good business plan layout details not only how the business will be formed, but also explains, in detail, how the business will be managed. Three main uses of business plans are:
Funding requirement – Many investors and donors require that a business plan be provided as part of the package they review when reviewing loan (or donation) applications of a business.
Continuation of a business – A well created business plan will help the owner make the necessary and important decisions to help grow the business; hence ensuring the continuity of the business.
Legal requirement for starting a business – For some business entities (corporations mainly), a business plan is a required document that must be submitted in order for the business to be legally registered. This is not a normal requirement for forming a small business.
Just like no two businesses are alike, no two business plans are alike. However, most business plans include at least the following segments:
- Executive summary
- Business description and structure
- Market research and strategies
- Management and personnel
- Financial documents
- Financial plans and projections
If you need assistance putting together your business’ plan, please call our office; we would be happy to assist you.
These five steps to starting a small business are, again, not the only steps but they are some of the steps that are normally skipped by new small business owners. Taking time to implement these steps as part of your business set-up process can help to ensure that your business not only grows but that it continues to exist in the future.
I hope this article has helped you as you start, or make changes, to your small business. If you have any questions regarding information shared in this article, please reach out to your CPA for further advice. Not working with an accounting consultant? Give us a call, we would be happy to work with you.
