Vlad Rusz is a CPA at Centaur Digital Corp, helping busy business owners efficiently manage their accounting system.
getty
Only a small percentage of Americans own a business, but that is increasing with the proliferation of side businesses and the gig economy. While your business might not be a traditional brick-and-mortar or even provide you with full-time employment, it’s helpful to think of any gig, side business or freelance work as a business.
Starting a business in the U.S. is fairly straightforward. Startup costs can be in the low hundreds if you opt to DIY, though that’s not recommended. But what can get complicated is understanding the legal, tax and accounting implications of running a business after you start one. Luckily, this is a relatively easy fix, and there are usually no significant legal or monetary ramifications for deficiencies if they are corrected early enough.
There is a wide breadth of unique business types, but thankfully there are common themes. In part one of this article, I explore legal structure and managerial accounting. Part two is dedicated to financial statements and business taxes. These four topics create a foundation for any business owner to better understand the legal, tax and accounting sides of their business.
Legal Structure
The legal structure of a business is how that business is treated in the eyes of the legal system. A sole proprietor is someone who is doing business under their personal name, which is commonly how freelancers and gig economy workers operate. Two individuals getting together to create a business is a de facto partnership, though one without any liability protection. In the U.S., this is legal, and in most states, no additional registrations are required for either of these structures.
You can, however, choose to set up a separate legal entity, which usually comes with the added protection of limited liability. One common structure is the limited liability company, but other structures include limited liability partnerships and corporations. Each type of business will have different legal requirements and methods of operating.
Understanding your business structure will ensure you have the right documents in place to operate legally. Keep in mind that most businesses where one person owns 100% will only see a nuanced difference in how their business is legally organized. While it’s important to understand legal structure, it’s a good idea to work with professionals to help you pick the right structure based on the specifics of your business.
When you start a business, your first step is usually to prepare the legal documents required, such as an operating agreement or corporate bylaws, and register with the secretary of state, or equivalent, in your state of residence. Although it’s trendy to register in states with zero tax, keep in mind that for single-owner businesses, your home state will tax your worldwide income, just like the federal government. Thus, you are unlikely to see any tax benefits and will have higher registration fees as you’ll need to register your out-of-state business in your home state.
Management Accounting And Treasury
A functioning accounting system is a must to determine the amount of tax you have to pay and to file the required reports. For small businesses, however, those reports are not timely enough to be used in daily management. For example, if you file an extension, most businesses only file taxes for the prior year in September, meaning that information is over nine months out of date. This is hardly timely enough to help in management decisions. Tax reports typically rely on financial accounting, while internal management decisions rely on managerial accounting. The two systems have some overlap, but for many small businesses, they can operate independently.
There are other accounting systems, such as simply using your online bank account or the envelope method. While they may lack detail, both will provide nearly instantaneous data to let you know how much money your business has. Along with other managerial accounting systems, these alternatives are often what small-business owners rely on in the day-to-day management of a company.
Small-business owners can outsource most of their financial accounting, and get professional help in choosing their legal and tax structure and setting up a managerial accounting system. There is one aspect, however, that should be kept in-house: the treasury department. This is the technical term for the person(s) that handles the cash, bank accounts and other assets in a business. In a large business, there are many checks and separation of duties that keep employees from misappropriating funds. In a small business, the treasury department is typically the owner, so no such safeguards are needed.
The business owner will be most involved in managerial accounting. Usually, this is done implicitly; after all, money needs to be collected from customers, and bills must be paid for the business to continue to operate. In addition, having everything in one system is not optimal and usually doesn’t work. As much as accounting software claims to do it all, it’s sometimes easier to use an Excel spreadsheet. What’s more, it’s sometimes easier to do more fluid and nebulous projections such as budgeting and capital investments with pen and paper.
Continue to part two of this article to learn about the financial statements and business taxes every business owner must understand.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Do I qualify?
