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Small Business Financials: Must Asked Questions

Starting and managing a small business comes up with many financial responsibilities that you being charged for basis on the laws and regulations in your country. Owning a small business means that you taxes, your company's financial records, billing, cashflows, and book keeping are one of the first actions and obligations that you have to consider.


This guide answers some of the most common questions small business owners have about financial management when starting a business. Even though the article covers the most of the questions and answers, it would be better for you to consult to an accountant before forming a company and start a business.


Small Business Owner Financial Questions


What Are My Tax Obligations?


As a small business owner, your tax obligations include income tax, self-employment tax, salex taxes.


Income Tax


Income tax is a tax imposed by governments on individuals and entities (such as businesses or corporations) based on their income or profits earned during a specific period, typically a fiscal year. It is one of the primary sources of revenue for governments to fund public services and infrastructure.


All businesses except partnerships must file an annual income tax return. Partnerships file an information return.


Many tax systems employ progressive rates, meaning higher income levels are taxed at higher rates. This aims to distribute the tax burden more equitably based on ability to pay.


Corporate Income Tax

Corporations and businesses are subject to income tax on their profits, which is the difference between revenues and allowable expenses. Corporate tax rates also vary by jurisdiction and may be influenced by factors like business size and industry.


Filling and Compliance of Taxes

Taxpayers are required to file tax returns annually, reporting their income and calculating their tax liability based on applicable tax laws. Compliance involves accurately reporting income, deductions, and credits to avoid penalties or audits.


Employers often withhold income tax from employees' wages or salaries, remitting these amounts to tax authorities on behalf of employees. This system helps ensure regular payment of taxes throughout the year.


If you hired new employees or are planning to hire, you should take tax withholding into account.


Self-Employment Tax


Self-employment tax is a tax specifically levied on individuals who work for themselves rather than being employed by someone else. It primarily funds Social Security and Medicare programs, similar to how employees and employers contribute to these programs through payroll taxes.


Self-employment tax ensures that self-employed individuals contribute to Social Security and Medicare, which provide benefits such as retirement income, disability benefits, and healthcare coverage (Medicare).


Tax Rate for a Self-Employer

As of recent updates, the self-employment tax rate is typically 15.3% of net earnings. This rate includes:


  • 12.4% for Social Security on earnings up to a certain limit (known as the Social Security wage base).

  • 2.9% for Medicare on all earnings.

  • For high-income earners, an additional 0.9% Medicare tax may apply on earnings above certain thresholds.


Self-employed individuals report their self-employment income and calculate self-employment tax using Schedule SE (Form 1040) when filing their federal income tax return (in the USA).


Sales Tax


Sales tax is a consumption tax imposed by state and local governments on goods and services sold to end consumers. It is typically added at the point of sale and collected by businesses on behalf of the taxing authority.


If your business sells goods or services, you may need to collect sales tax from customers.


Online sales taxes are applied at checkout as a percentage of the total purchase if the purchased items or services are taxable. Depending on the jurisdiction (state, country, city), different tax rates may apply to different types of goods.


Some of the items or transactions may be exempt from sales tax based on state laws. These examption include grocery items, prescription medications, and certain medical services in some countries or states.


How Should I Structure My Business?


Choosing the right business structure is vital for tax purposes and legal protection. Common structures include sole proprietorship, partnership, corporation, limited liability company (LLC).


Since you will be a small business owner, you will probably form a sole proprietorship or LLC company.


Sole Proprietorship


A sole proprietorship is the simplest and most common form of business organization in the United States. It is an unincorporated business owned and operated by a single individual. Here are the key characteristics and considerations of a sole proprietorship:


Single Ownership: The business is owned and managed by one individual, known as the sole proprietor.


No Legal Distinction: There is no legal distinction between the owner and the business. The owner is personally responsible for all the business's debts and obligations.


Easy to Form and Dissolve: Establishing a sole proprietorship is straightforward and involves minimal legal formalities. Dissolving the business is also relatively simple.


Full Control: The sole proprietor has complete control over all business decisions and receives all profits generated by the business.


Taxation: The business itself is not taxed separately. Instead, profits and losses are reported on the owner's personal income tax return (Form 1040, Schedule C). The owner also pays self-employment taxes on the business income.


Minimal Regulatory Requirements: Sole proprietorships typically face fewer regulatory requirements and less paperwork compared to other business structures.


Limited Liability Company (LLC)


A Limited Liability Company (LLC) is a popular business structure in the United States that combines the liability protection of a corporation with the tax benefits and operational flexibility of a partnership or sole proprietorship.


Limited Liability: Owners (referred to as members) are generally not personally liable for the company’s debts and liabilities. This means their personal assets are protected if the business incurs debt or faces lawsuits.


Flexible Management: LLCs can be managed by the members (owners) or by appointed managers. This flexibility allows for different management structures that can suit the needs of the business.


Tax Options: An LLC offers various tax options. It can be taxed as a sole proprietorship, partnership, S corporation, or C corporation, depending on the number of members and the election made by the LLC.


Separate Legal Entity: An LLC is considered a separate legal entity from its owners, meaning it can own property, enter contracts, and conduct business in its own name.


Formation Requirements: Forming an LLC requires filing Articles of Organization with the state and paying the applicable fees. Each state has its own regulations and requirements for LLC formation.


What Records Should I Keep?


Proper record-keeping is essential for tracking your business’s financial health and meeting legal requirements. Keep the following records:


Income Records


An income record is a detailed account of all the revenue generated by a business over a specific period. For small businesses, maintaining accurate income records is crucial for several reasons, including financial planning, tax reporting, and performance evaluation.


These records typically include sales receipts, invoices, bank statements, and other documents that reflect incoming funds. By keeping precise income records, small business owners can monitor their revenue streams, identify trends, and make informed decisions about pricing, marketing, and inventory management.


For small businesses, income records serve as the foundation for preparing financial statements such as profit and loss statements, balance sheets, and cash flow statements. These documents provide a comprehensive overview of the business's financial health and are essential for securing loans, attracting investors, and making strategic business decisions.


Additionally, accurate income records are necessary for filing accurate tax returns and claiming deductions, helping small business owners comply with tax regulations and potentially reduce their tax liabilities.


By prioritizing meticulous income record-keeping, small businesses can ensure their financial stability and position themselves for growth and success.


Expense Records


An expense record is a record of all the costs incurred by a business over a specific period. For small businesses, maintaining detailed and accurate expense records is essential for effective financial management and operational efficiency.


These records typically include receipts, invoices, bank statements, and other documents that verify expenditures on items such as supplies, utilities, rent, payroll, and marketing.


By meticulously tracking expenses, small business owners can monitor their spending patterns, control costs, and ensure that they stay within budget.


Expense records are also critical for tax purposes, as they support the deductions claimed on tax returns. Proper documentation of business expenses can help small businesses maximize their tax deductions and reduce their overall tax liability.


Moreover, detailed expense records facilitate the preparation of financial statements, such as profit and loss statements, which provide insights into the business's financial performance and profitability.


Bank Statements


A bank statement is a document provided by a bank that summarizes the financial transactions and balance of an account over a specific period, typically a month.


For small businesses, bank statements are vital tools for financial management and record-keeping. They detail all deposits, withdrawals, checks written, and fees charged, allowing business owners to track their cash flow, reconcile accounts, and ensure that their financial records are accurate.


For small businesses, regularly reviewing bank statements is essential for maintaining financial control and detecting any discrepancies or unauthorized transactions. Bank statements help in reconciling the business's accounting records with the bank's records, ensuring that all transactions are accurately recorded and accounted for.


Payroll Records


Payroll records are comprehensive documents that track all the information related to employee compensation within a business.


For small businesses, maintaining accurate payroll records is critical not only for compliance with labor laws and tax regulations but also for fostering trust and transparency with employees.


These records typically include details about employee wages, salaries, bonuses, deductions, hours worked, overtime, and any other forms of compensation. Additionally, payroll records should document all tax withholdings and contributions to benefits such as retirement plans and health insurance.


For small businesses, meticulous payroll record-keeping is crucial in avoiding costly legal issues and penalties. Accurate payroll records ensure that employees are paid correctly and on time, which is vital for employee satisfaction and retention.


These records also provide essential data for financial planning and budgeting, helping business owners understand their labor costs and make informed decisions about hiring, raises, and promotions.


Tax Records


Copies of filed tax returns, tax payments.


How to Reduce My Tax Bill?


To minimize your tax liability:


  1. Claim All Deductions: Business expenses such as office supplies, travel, and marketing can be deducted.

  2. Take Advantage of Tax Credits: Credits for small businesses, like the Research & Development tax credit, can reduce your tax bill.

  3. Plan Retirement Contributions: Contributions to retirement plans like a 401(k) or SEP IRA can lower taxable income.

  4. Depreciate Assets: Deduct the cost of business property over its useful life.

  5. Consider an S Corporation: To reduce self-employment taxes, consider electing S Corporation status.


What Are My Financing Options?


Funding is critical for growth and operations. Consider:


Bank Loans


A bank loan is a sum of money borrowed from a bank that must be repaid with interest over a specified period. The terms of a bank loan, including the interest rate, repayment schedule, and fees, depend on the borrower’s creditworthiness, the purpose of the loan, and the lender’s policies.


Type of Loans

Term Loans

A lump sum of money repaid over a fixed term with regular payments of principal and interest. Term loans can be short-term (up to 1 year), medium-term (1-5 years), or long-term (over 5 years).


Lines of Credit

A flexible loan that provides access to a predetermined amount of money. Borrowers can draw on the line of credit as needed and pay interest only on the amount used.


SBA Loans

Loans backed by the Small Business Administration (SBA), which reduces the risk for lenders and makes it easier for small businesses to qualify. Popular SBA loan programs include the 7(a) Loan Program and the 504 Loan Program.


Equipment Loans

Loans specifically for purchasing business equipment. The equipment itself often serves as collateral for the loan.


What Business Expenses Can I Deduct?


  • Office Supplies: Items such as paper, pens, staples, and other consumables used in the day-to-day operations of your business.

  • Rent and Utilities: Costs of renting office space and utilities such as electricity, water, and internet. If you have a home office, a portion of your rent or mortgage and utilities may be deductible.

  • Business Travel: Expenses for business-related travel, including transportation (airfare, car rental, taxi fares), lodging, and meals. Keep detailed records and receipts.

  • Meals and Entertainment: 50% of business meal costs are typically deductible if the meal is directly related to business activities. Entertainment expenses are generally no longer deductible.

  • Advertising and Marketing: Costs associated with promoting your business, including advertising, website expenses, business cards, and promotional materials.

  • Employee Salaries and Benefits: Wages, salaries, bonuses, and commissions paid to employees. Employee benefits such as health insurance, retirement plans, and other fringe benefits are also deductible.

  • Professional Services: Fees paid to lawyers, accountants, consultants, and other professionals for business services.

  • Insurance: Premiums for business insurance policies, including liability insurance, property insurance, and workers' compensation insurance.

  • Depreciation: The cost of purchasing business assets (such as equipment, vehicles, and buildings) can be deducted over time through depreciation.

  • Interest on Business Loans: Interest paid on loans used for business purposes is generally deductible.

  • Training and Education: Costs for continuing education, seminars, workshops, and training that improve skills related to your business.

  • Software and Subscriptions: Costs for business-related software, online services, and subscriptions to industry publications.

  • Office Expenses: Small equipment, furniture, and supplies needed to run your office.

  • Telephone and Internet: Costs for business-related phone and internet services. If you use your personal phone or internet for business, you can deduct the business portion.

  • Vehicles: Expenses related to the business use of a vehicle, such as fuel, maintenance, insurance, and depreciation. You can use the actual expense method or the standard mileage rate to calculate the deduction.

  • Rent or Lease Payments: Payments for renting or leasing equipment, machinery, or vehicles used in your business.


Home Office Deduction


If you operate your business from home, you may be eligible for the home office deduction. To qualify, the home office must be used exclusively and regularly for business. You can deduct a portion of your home expenses, such as mortgage interest, rent, utilities, and insurance, based on the percentage of your home used for business.


Health Insurance Premiums


If you’re self-employed, you can deduct the cost of health insurance premiums for yourself, your spouse, and dependents. This deduction is taken on your personal tax return and not as a business expense.


What Accounting Software Should I Use?


Choosing the right accounting software depends on your business size and needs. Popular options include:


QuickBooks


Comprehensive and user-friendly, ideal for small to medium businesses.


Xero


Cloud-based with strong integration features.


FreshBooks


Great for service-based businesses with excellent invoicing.


Wave


Free option suitable for very small businesses (USA and Canada businesses only).


Zoho Book


Integrated with other Zoho business apps.


Should I Change My Tax Withholding?


Review your tax withholding periodically, especially if you experience significant changes in income or deductions. Adjusting your withholding can help avoid large tax bills or refunds.


How Should I Keep My Books?


Maintaining accurate books is crucial for financial health and tax compliance:


  1. Choose a Method: Decide between cash basis or accrual accounting.

  2. Set Up a Chart of Accounts: Organize your finances into categories.

  3. Use Accounting Software: Automate and simplify record-keeping.

  4. Reconcile Accounts Regularly: Compare your books with bank statements to catch discrepancies.

  5. Seek Professional Help: Consider hiring an accountant or bookkeeper for accuracy and compliance.


Even though understanding and managing your business's financial responsibilities can seem daunting, with the right knowledge and tools, you can ensure compliance, optimize your tax situation, and set your business up for financial success. Always consider consulting with a financial advisor or accountant to tailor advice to your specific business needs.

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