BlodgettVentures.com

Keep your small business accounting system simple.

 I have seen quite a few companies struggle through the process of setting up and maintaining the financial side of their business. They usually overspend on this because they are worried about messing things up.

Here are some basics:

1) Keep things simple. If you are starting or already operating a small business, get a simple accounting package such as QuickBooks or Quicken. While you are small, keep your system simple, and try to do the work yourself or with a part-time helper who knows how to set up and maintain a simple bookkeeping system. You don't need a high-powered controller, chief financial officer or accountant in the early stages. You can always hire one by the hour to help you at month-end and year-end closings.Your CPA may be able to recommend someone.

2) Use a payroll service. If you have payroll, use a payroll service like ADP or Paychex. They do it inexpensively and will be able to expand with you as your business expands.

3) Get a good CPA. If you haven't already done so, find a good CPA to handle your business tax matters and counsel you on issues related to maintaining your financial systems.

S Corporations are corporations that have elected to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. It has the legal protections and environment of a C Corporation, but is taxed much like a partnership. Like a C corporation, an S corporation is valid under the law of the state in which the entity is organized. S corporations are separate legal entities from their shareholders and generally provide their shareholders with immunity from personal responsibility for corporate debt, unless there has been a personal guarantee. As with partnerships, the income, deductions, and tax credits of an S corporation flow through to shareholders annually, regardless of whether distributions are made. Thus, income is taxed at the shareholder level and not at the corporate level. Payments to S shareholders by the corporation are distributed without being taxed first, as they would be in a C corporation.

Advantages or S Corporations. In general, S Corporations do not pay any income taxes. Instead, the corporation's income or losses are divided among and passed through to its shareholders. The shareholders must then report the income or loss on their own individual income tax returns.

Disadvantages of S Corporations. I've noted that S Corporations that have passed through all of their profits to shareholders have a struggle during tough economic times. They have little or no reserves to carry them through recessions, and must turn to borrowing or loans from shareholders to get operating funds. This can mean borrowing during times when money is tight, and expensive.  

A Limited Liability Company (LLC) is an entity that on the one hand gives you limited liability, like a corporation, and on the other hand, it works much like a partnership. It's a separate legal entity, but there is no stock. Instead of having Shareholders and Corporate Bylaws, an LLC has Members and an Operating Agreement. It's fairly new, but quite popular with small companies from 1-5 principals. 

Advantages of a Limited Liability Company. Taxes are passed through to the members. Limited Liability for its Members. Fewer formalities. No stock, and much less complicated in terms of filings, taxation and stock.

Disadvantages of a Limited Liability Company. Not as many tax benefits as a corporation. 

Corporation? Sole Proprietorship? Partnership? Limited Liability Company? What small business structure should you use? I've owned them all. Each has its benefits and drawbacks. I'll try to cover them starting with the simplest.

Proprietorship. This is an entity that is an extension of you, and it has no legal existence separate from you. You are the sole responsible party and have no partners. You are the recipient of the revenues you generate and are solely committed to paying any debts you incur. If you name the business (a trade name) something other than your own given name, i.e., Exceptional Consulting Company, you may need to file for a DBA, a legal registration called "Doing Business As," generally in the county in which you are operating. Normally, if you use your surname as your business name, there is no DBA filing required. If you use a trade name, banks usually require a copy of the DBA filing paperwork for you to open a business account.

Advantages. Start immediately. You may already have a potential client who knows you personally and will readily do business because of that prior relationship. You can always form a Corporation or Limited Liability Company later, as your business prospers. For taxation purposes, all of the profits (losses) flow to your personal tax return.

Disadvantages. Personal liability for all debts, lawsuits and claims. Your legal and financial life is completely co-mingled with the business. If you were to die, the business ceases. It's difficult to borrow money as a proprietorship, and virtually impossible to attract investors or buyers as you grow or decide to sell the business.

Partnership. This is a business entity that operates much like a sole proprietorship except that you will have one or more partners who share in the work, as well as in the profits (losses) of the business.

Advantages. Starting a partnership is as simple as two or more people agreeing to share their talents, efforts, knowledge and resources to the task of operating a business together. They should document this agreement with a written partnership agreement. A good partnership agreement should outline the duties, responsibilities and financial consideration (investment) of each partner, as well as how and when profits and losses are distributed. It should also outline how debts are incurred and who is responsible for paying such debts if the business doesn't have the funds. The agreement should also cover how the business Generally, partners are legally jointly and severally liable for the debts of the business.

Disadvantages. While simple to form, partnerships are extremely complex in functionality, and a minefield for potential problems. Partnerships generally are short-lived due to unrealized expectations and unforeseen occurrences, such as cash flow difficulties, disputes among the partners, death of a partner and other legal challenges. Beware of partnerships.

Joint Venture. If you must partner with someone, make it a Joint Venture. A Joint Venture is an association between one or more entities; generally, formed for a purpose such economic gain of some kind. This type of association or alliance (it could be a Partnership, Limited Liability Company or Corporation) usually exists for a period of time while the economic opportunity is pursued and is dissolved when the purpose is fulfilled or the parties agree to such.

Advantages. Quick to form, requiring an agreement on purpose, activities, investment, profits and loss splits and dissolution.

Disadvantages. Usually short term life, or life for single purpose. Not generally appropriate for conducting an ongoing business.

Corporation. A corporation is a stand along legal entity that conducts business separate from its owners. Shareholders own the stock, elect a Board of Direcotrs. Officers are appointed, and they run the company. Sometimes you may wish to be a 10% owner of the stock. Then you would appoint yourself as an officer, or all officers. There are rules for conduct and operation called Bylawas, which can be modified as the business needs evolves.

 Advantages. Limited Liability. Unlike the sole proprietorship, where the business owner assumes all the liability of the company, an individual shareholder's liability is limited to the amount he or she has invested in the company. A sole proprietor's personal assets, such as your home or auto can be seized to pay the debts of your business; as a shareholder in a corporation, you can't be held responsible for the debts of the corporation unless you've given a personal guarantee. (Never do this!) The corporation has the same rights as an individual: can own property, do business, incur debt and sue or be sued. Corporations operate in perpetuity. A corporation has an unlimited life span; the corporation continues to exist even if the shareholders die or leave the business, or if the ownership of the business changes. Raising Money Is a Bit Easier. Corporations also have more ability to raise money, which may make it easier for your business to grow and develop. While corporations can borrow and incur debt like any sole proprietorship, they can also sell shares and raise equity capital, a big advantage because equity capital generally does not have to be repaid and incurs no interest. Income Control. You can determine when you personally receive income, a real tax advantage. Instead of getting your income when it's received, being incorporated allows you to receive income at a time when you'll pay less in tax. Potential Tax Deferral. Becoming incorporated gives you tax deferral potential. Because you can defer paying some tax until a later time, you may be able to realize tax savings if you are then in a lower tax bracket, or if the tax rates have fallen.Income Splitting. Another tax advantage of incorporating is income splitting. Corporations pay dividends to their shareholders from the company's earnings. A shareholder does not have to be actively involved in the corporation's business activities to receive dividends. Your spouse and/or your children could be shareholders in your corporation, giving you the opportunity to redistribute income from family members in higher tax brackets to family members with lower incomes that are taxed at a lower rate. The Small Business Tax Deduction. If you incorporate your small business, your corporation may qualify for the small business deduction. This annual tax credit is calculated at the rate of 16% on the first $200,000 of taxable income, which may be a much lower tax rate than that applied to your personal income. Increased Business. Being a corporation may be looked upon favorably by your customers and potential customers. People perceive corporations as being more stable than unincorporated businesses.

Disadvantages. increases in paperwork and cost, which can be substantial compared to a sole proprietorship or partnership. There may be less tax fexibility. As a sole proprietor, if your business experiences operating losses, you could use these to reduce other types of personal income in the year the losses occur. In a corporation, however, these losses can only be carried forward or back to reduce the corporation's income from other years. Registering A Corporation is Expensive. A corporation is a more complex legal structure than a sole proprietorship or partnership, so it's logical that creating one would be more complicated and costly. Fees for incorporating a small business either provincially or federally range in the hundreds of dollars - and that's just for the set up. I've already mentioned the increased maintenance and related fees, such as increased accounting costs.

Limited Liability Company (LLC). A Limited Liability Company is similar to both a corporation and a partnership. Profits and losses are passed through to the owner(s) tax returns, but it also has the liability protection of a Corporation.
Like a corporation, it is a separate legal entity; unlike a corporation, there is no stock and there are fewer formalities. The owners of an LLC are called "Members" instead of "Shareholders". So in essence, it's a like a corporation, with less complicated taxation and stock formalities. A Limited Liability Company uses an "Operating Agreement" which sets the rules for operating the company and can be modified as the business grows and changes, like corporate "Bylaws." Operating an LLC is generally not as formal as a corporation, requiring an Annual Members' Meeting and Members' agreeing to changes of the Operating Agreement and any other company policies and practices warranting discussion.

Advantages. Provides the liability protection of a corporation without the corporate formalities (Board meetings, Shareholder meetings, minutes, etc.) and extra levels of management (Shareholders, Directors, Officers). Taxed the same as a sole proprietorship (1 Member LLC) or partnership (2 or more Members). May be a good choice for 1-5 person startups, and has recently surpassed corporations in popularity. Easy management and limited compliance requirements have made the LLC a popular solution for small business.

Disadvantages. Usually more expensive to form than a DBA, requires more paperwork and formal behavior. Not able to write off all of the expenses that are allowable for corporations.