We hear all the time how most small businesses fail, and yet, people continue to open new businesses all the time. Often times though, we are unprepared for what it really takes to succeed as a small business owner.
I work with a lot of small businesses and I see two major causes of struggle. First, we use our businesses as our own personal piggy banks, and second we fail to understand and plan for taxes. Neither of these is conducive to business success.
As we start making money, we put it in our business checking account like we know we’re supposed to do. Along the way we see money sitting in the bank, so we take some out. We need to get paid for all our hard work don’t we? Usually small business owners have no idea how much to pay themselves or when to do so. Frequently, they simply use the business debit or credit card to pay their personal expenses. This not only means they don’t know how much they’re taking out, but it also means extra work to keep the bookkeeping clean. If you don’t keep accurate records of your draws, you will not be able to determine how much money the business actually made.
Then the tax man comes knocking on the door. Whether it’s sales tax, payroll tax or income tax, we often don’t even realize when these are due or how much we owe. Sometimes, if we’ve kept good records, we can figure out accurately what we owe. And then, it’s time to buy more supplies, pay our bills or invest in a marketing campaign …and there’s no money in the bank.
So how does a small business owner avoid this dilemma?
Knowledge and planning. Yep, we need to educate ourselves and we need to plan on paying Uncle Sam. What most small business owners fail to realize Is that we are required by the government to collect sales tax (if we sell taxable products) and payroll tax (if we have employees) on its behalf, and then pay it over by set deadlines. As self-employed folks, we are required to estimate our quarterly income tax and prepay that too.
So what does all this really mean to you? It means, every time you sell a taxable product and collect the sales tax due, you are holding money that doesn’t belong to you, it belongs to Uncle Sam. Also, every time you pay an employee and withhold tax from their paycheck, you are keeping money that doesn’t belong to you. And, if you fail to pay an estimated quarterly income tax payment, you are keeping money from the government that you will ultimately be responsible for paying. The bottom line is, if you spend any of these funds, you’re spending money that’s not yours to spend.
What happens then? If you spend money that you’re supposed to have available when it comes due, you’ll need to come up with more to replace it before the deadline. Frequently entrepreneurs realize this but figure they have plenty of time to bring in the funds. BIG MISTAKE! You’re gambling at this point. Not a smart way to run a successful business. Too often this becomes a downward spiral.
A much wiser, more realistic approach is to set up a tax savings account and make payments into this account on a regular basis. For example, if you collect sales tax, you should transfer funds equal to the tax collected into the savings account every week. You will feel it less if you do it frequently. If you do not have the funds in your business checking account, you will be less tempted to spend them. Do the same thing with your income tax. Every time you pay yourself, pay a percent (based on what tax bracket you usually fall into) of your take home pay into the savings account. For payroll tax, the easiest solution is to pay the amount due each time you pay payroll.
The second half of the equation is not to pay yourself until you’ve completed your bookkeeping for the month and have determined whether or not you’ve made a profit. This is where cash flow planning comes into play and can make all the difference in the success of your company.
Simple, but not necessarily easy, I know. But don’t fool yourself, the money you collect for the government is not yours. Don’t spend it, save it until it’s due and pay it on time. Also, it is important to know that if you fail to pay your sales tax, the state will revoke your resale permit, essentially shutting down your business. If you fail to pay your payroll taxes, you can face jail time. Income tax is a little less severe, but if your business fails and you still owe income tax, you will still have to pay it even if you no longer own the business.
So, before you start your new business, educate yourself and make a solid plan. It can be the difference between success and failure.