Statistically Speaking

I read an interesting article recently in the CPA Practice Advisor and felt compelled to address some of the frightening statistics quoted.  I keep saying, where have all these people who have resigned during the great resignation gone?  How are they making a living?  As I suspected, they are opening their own businesses.

“During 2021, a record-breaking 5.4 million new business applications were filed, according to U.S. Census Bureau data.”

My fear has been that all these eager new entries into entrepreneurship are not prepared for the reality of the complexities of business ownership, and this article validates my concerns.  

“However, many new entrepreneurs are navigating an environment of higher inflation, shrinking profit margins, suboptimal business bookkeeping practices, and financial uncertainty that could put their companies at risk.”

The fact that “suboptimal business bookkeeping practices” is listed as a top reason these young companies are at risk doesn’t surprise me.  However, it does concern me, so I thought I would analyze the four statistics the author lists as the issues that affect this area.  

What I find interesting is that the other issues are specific to today’s economy, but having suboptimal business bookkeeping practices has nothing to do with the times.  This is a common reason throughout time that small businesses fail.  I’ve seen it too many times and I truly believe that the high rate of business failures through time is due primarily to this weakness.

“Our survey found that small business owners are making a variety of rookie mistakes with their business finances:

• 26% of small business owners admit to not paying themselves a salary
• 35% confess to blurring the lines between personal and business accounts
• Only 48% of microbusinesses (with less than 10 employees) have a small business bank account
• 13% of respondents are still using drawers or shoeboxes to keep track of receipts”

Let me break this down one statistic at a time, as all these problems are easily avoidable.  If you or someone you know has just started a small business, now is the time to make any needed changes to avoid these “rookie mistakes.”

First, 26% of small business owners admit to not paying themselves a salary.

This means the majority of folks are doing so. But what this statistic doesn’t address is why aren’t these 26% paying themselves?  And should you be paying yourself a salary?  I’m not sure what the survey considers a salary, but I would argue that a salary may not be a good idea for a new entrepreneur.  

If your business is not yet making a profit, then you shouldn’t be taking any money out for yourself, either as a draw or as salary.  Therefore, the 26% who aren’t taking any money out may be in a stronger position than the other 74%.  However, if a company is earning a profit, which is always the goal, then the owner should be earning some income.  

If the company is set up as a sole proprietorship, as most solopreneurs are, then it is easiest to simply take draws when the company has the cash flow to support them.  If the company is set up as an LLC that files taxes as a corporation or is set up as a corporation, then it is required that the owners pay themselves a salary when the company is profitable.  Not being a CPA myself, I won’t quote any specific point when that is true but would recommend that you check with your tax adviser to find out when you will be required to pay out salaries to the corporate officers.  

Either way, I would avoid paying salaries until the company can afford to pay them and to add the complexity and expense of having true payroll.  To take a draw, all the owner must do is give themselves money (check or transfer to a personal account), making sure it is recorded correctly on the books.

Second, 35% admit blurring the lines between personal and business accounts.

Not surprising, as most small business owners fund their businesses out of their personal finances.  There’s nothing wrong with that if you have the resources to do so.  However, it is critical to track all your business expenses in one place.  

The smart entrepreneur knows to set up a proper business accounting system from the beginning.  Thus being able to track every penny spent for the business.  Your CPA will thank you when it comes to tax time.  The government is very particular about seeing your business income and expenses separated from your personal finances.  Also, it is smart because you want to be able to take advantage of the write-offs you get for business expenses.

If you failed to do this, a good accounting professional can help you get the information tracking into your business accounting correctly.  Remediation is still possible if you haven’t filed your business taxes for last year yet.  If you have, then make the necessary changes quickly and backtrack to the beginning of this year.

Third, only 48% of microbusinesses (with less than 10 employees) have a small business bank account.

This one doesn’t surprise me as I’ve seen it time and time again.  But the good news is that more than 50% of these budding entrepreneurs have done so.  

This aligns with the second issue.  If you don’t have a business bank account, it is very challenging to keep your business expenses separated from your personal ones.  Again, separating will help you claim all relevant business expenses, which will give you the best possible tax advantages.

It is a simple one to remedy. Just contact your favorite bank and open a new account in the business name.  Whether you are a corporation or a sole proprietor will make some difference on the account they will offer you, but it’s a simple, necessary step.

Once you have the account established, you can transfer profits to yourself when appropriate.  If your business needs additional funds to carry it during start up or when things slow down and you need to infuse cash, simply write a check or make a transfer from your personal account into your business account.  Just make sure to record it properly on the books.

Fourth, 13% of respondents are still using drawers or shoeboxes to keep track of receipts.

Not ideal, but the statistic is low so that indicates most people know there are easier ways to keep track of the necessary back up documentation.  

Yes, the IRS still requires that you keep copies of all your receipts.  The good news is that they can be digital and good accounting software will usually include a feature that allows you to snap pictures of your receipts and attach them to the corresponding transactions.  This is the simplest most streamlined way to protect yourself in case of an audit.

If you don’t have the capacity to do this on your phone, then buy an inexpensive scanner and do it at the end of every week.  Don’t wait any longer as you will likely lose track of the tiny slips of paper.  

Also, remember to write on the receipts what it was for so you can post it correctly in your accounting program.  

As long as you have digital copies that you can produce in the event of an audit, then you can ditch the hard copies.  Also, a word of warning, credit card statements are NOT considered sufficient back up. You must show the receipt for the specific purchase.

If you get audited and cannot prove any purchase made was legitimately for the business, the IRS will toss it out and you won’t get to use it as a deductible expense.  You want to be sure you get credit for everything spent on behalf of the business, so back up documentation is critical.

Lastly, if you are one of the 5.4 million new business owners, kudos to you for jumping into business ownership.  Just remember that we are living in challenging economic times and having strong business bookkeeping is a must. This alone is no guarantee that you will succeed, but it will go a long way to helping you steer your company based on factual financial data.  Given the high rate of failure for small businesses, doing everything you can to set yourself up for success is critical.

To read the full article quoted – READ HERE

Sherry Lutz Herrington is the owner of Sherrington Financial Fitness, a business consulting and accounting firm specializing in strategic business planning and solid financial accounting for businesses. She is also the author of Strong Women Thriving (www.strongwomenthriving.com), a blog which focuses on empowering women to be financially savvy, particularly after experiencing financial abuse. Sherry is currently writing a book that both shares her personal story and addresses financial abuse. She can be reached at hello@sherringtonfinancial.com.

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