There are a few fundamentals that every business must have in order to operate as a business. First and foremost is the fact that your primary objective is turning a profit. Even the IRS takes the position that if all you do is continuously generate losses they will consider your “business” a hobby and disallow your losses. There not only needs to be a profit motive but a profit generated. This may seem like a no-brainer to you but in my 30+ years of experience I have seen far too many startup generate nothing but expenses and there are some good reasons for that which I will cover next.
Before quitting your day job to open your 1st business I suggest checking off on a few items of importance. The first item on your list is to have a product or service that people will actually pay for. Not something you think they will pay for because in the end it doesn’t matter what you think, it’s what “they” think. That’s the plain, simple truth. If you’re not sure about it then before you spend tons of cash and bankrupt yourself do some testing. Use your circle of friends and family and then their circle of friends and family. It’s important to be able to get people that don’t already know, like and trust you to buy. If you can show that without a shadow of a doubt that you have something that will generate revenue continue reading. If not the rest of this article is of no use to you.
Once you determine that you have a product or service that will generate revenue these are the next steps you need to take and why:
1: Prepare a monthly personal expense budget.
You need to determine how much you need to generate in distributions from your business to at least meet your monthly outlay. Unless you are already out of work with no other income options you need to keep paying your bills. Don’t just quit your job unless you have at least a year’s worth of savings to carry you through.
The reason for this is that without a cushion you will feel the stress of having to make money. Stress clouds our judgement and drains our energy. You always need to be in tip-top shape mentally and physically. You’re going to have enough distractions and obstacles to begin with and don’t need to add any self imposed burdens on yourself. Additionally, knowing what you need is 1,000 times better that operating in the dark. Knowing your numbers is essential if you want to run a successful enterprise.
On the next page is a simple worksheet to help you determine your monthly nut. Don’t make the mistake of omitting things like meals and entertainment, vacations, holidays, birthdays and the all important surprises that are sure to occur like car and home repairs. If you have children leave a nice big fudge factor. This is just your expenses, not revenue and not even broken out on a monthly basis. It’s just an estimate so don’t go into needless details. Keep it simple!
PERSONAL MONTHLY EXPENSE SCHEDULE
CREDIT CARD PAYMENTS
After checking off the personal expense budget one of two things will happen.
- Reality will set in and you will realize that starting a business is a big risk not worth taking or to proceed with caution.
- You want to go on to the second item on the list.
2: Prepare a schedule of startup cost.
These are all the expenses and capital investments associated with getting the business off the ground before you start generating revenue. This is another potential blow to your plans on starting a business. Reason being is that entrepreneurs are full of enthusiasm and optimism which is needed but also one of the characteristics that get us into trouble. Getting the numbers down on paper and reviewing them accomplish a few objectives. It brings us down to earth revealing exactly what’s at stake financially. It’s also the first step in learning how to know your numbers. You will learn that part of running a successful business is knowing your numbers.
BUSINESS STARTUP COST
1ST MONTH RENT/RENT SECURITY
3: Prepare a schedule of monthly business expenses.
Going back to fundamentals, you need to generate positive cash flow which is not the same as generating revenue. Positive cash flow occurs when your revenue exceeds your expenses. This must exceed expenses (net profit) to the point that it covers your personal expenses, the 1st schedule on the list. If these numbers don’t work you’re going to put stress on yourself and nothing positive comes from stress. That’s why I strongly suggest having the 1 year expense cushion.
I realize that these numbers are only estimates and that your actual expenses will be different. I highly recommend overestimating these because inevitably you will get hit with unexpected expenses, both business and personal.
MONTHLY BUSINESS EXPENSES
SUBSCRIPTIONS (WEB HOSTING,
ACCOUNTING & BOOKKEEPING
AUTO (GAS, REPAIRS & INSURANCE)
This is a simple list outlining the basic issues every small business must address. It’s highly advisable that you know and have a general understanding all of these areas before making any decisions about formally starting your business. I can guarantee that if you don’t address these issues now you will be forced to address them later, hopefully not under duress when you are more likely to make mistakes.
These are your options when it comes to your legal structure as a business. If you don’t formally choose one of these you are a Sole Proprietor by default. If you don’t formally set up your Not-For-Profit you can face some serious legal repercussions. Before you do anything seek the advice of a good accountant. I say accountant and not an attorney because most attorneys are not versed in tax strategies and choosing the wrong structure can cost you a significant amount of money.
Not for Profit
Most small businesses should be structured as an “S Corp” for legal and tax planning purposes. I’ve seen many new business owners choose to be structured as an LLC without knowing the tax implications. I have included an article on being taxes as an LLC and self employed vs being taxed as an “S Corp”.
Not for Profit issues:
It may seem obvious but you would be surprised by how many individuals mistakenly think they can set up a Not for Profit to make money. Not for Profits do occasionally pay salaries if it’s in their budget but there seems to be a general misunderstanding about how and why these entities are created. That is why I am addressing it here.
There are several types of Not for Profit organizations. Many people believe that every Not for Profit organization can accept tax deductible donations. They may be able to accept donations but in order for them to be tax deductible it must be set up as a 501 (C) 3 corporation. A 501(C) 3 organization is not simple to set up and must first be organized under state law and then go through a rigorous IRS process to be approved as a charity. The organization is exempt from Federal and State income taxes as long as the money received is consistent with it’s Not for Profit purpose. I believe that this is where the confusion takes place.
Case in point-The NCAA is a Not-for-Profit college basketball tournament. They receive millions of dollars in advertising revenue from the tournament and had to pay millions of dollars in corporate income tax on that revenue because it was what the IRS considers “Unrelated business income”. It had nothing to do with the organizations Not-for-profit status.
So if you want to start a Not-For-Profit do it because you want to make a difference, not because you want to make money.
DBA- another misunderstood concept. A DBA (Doing business as) is for a sole proprietor which distinguishes the individual from the business. There is no legal separation with for a sole proprietor meaning that the owner is personally legally liable for any business conducted. A DBA is usually your business name, registered with a local jurisdiction such as a county clerk. In order to set up a business bank account you will need to get a DBA.
Tax identification # – You need this to open a bank account and conduct business when you form a business entity beyond being a sole proprietor. You also need a tax id number if you’re a sole proprietor with employees. You get a tax id# by registering with IRS.
Payroll registration -If you are paying wages either to yourself or employees you need to notify IRS (usually when you apply for your tax ID) and the state you are doing business in. Each state requires you register to file and pay unemployment taxes and requires a separate registration number beside your Federal Tax ID#.
Payroll Compliance – This is a big one and way to much to cover here but here are the bullet points:
Hiring- Forms W4 and I9
Withholding and employment taxes
Remitting “trust fund” and employment taxes
Employee vs. Independent Contractor – I mention this because it’s a very big topic with IRS and state agencies and insurance companies. It comes down to payroll taxes and insurance risks so “they” are scrutinizing these classifications with a microscope. It’s your responsibility to learn what the difference is and how you want to classify those workers in the “grey” areas. A mistake here can cost you plenty.
Insurance – A really good advisor is needed on issues from commercial liability, truck and auto, etc. If you have payroll you MUST have workers compensation AND Disability. For some reason many employers forget about the disability part and I’ve seen way too many bad brokers get the workers compensation set up and forget about the disability.
Sales tax – A lot of businesses sell goods and services that are not subject to sales tax. Don’t assume you’re one of them. Sales tax probably the most complicated and hardest tax to calculate and fully comply with. My advice is to assume everything is taxable. Check with your state agency for the details including if you need to be registered as a sales tax vendor or not.
Books & Records – one of the easiest concepts to learn and one that wreaks fear in any business owner that has received a letter stating something to the effect of “We command you to bring your books and records to IRS agent… “
Every business, and every organization for that matter needs to keep proper books and records. Very not sexy and boring but required. I recommend getting IRS Publication 583 “Starting a business and keeping records” for starters.
This is just a beginning. If you feel overwhelmed at this point I suggest keeping your job instead of starting a business. It takes a lot to be your own boss. It sounds like fun but until you try it for real you can never truly know all that’s involved.