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This article is for educational purposes and does not constitute legal, employment, or tax advice. For specific advice applicable to your business, please contact a professional.
There are a few common financial mistakes small business owners might make that could be avoided with the right planning and tools. Here are a few money mistakes to keep your eyes on as we start off the new year.
Mixing business and personal accounts
Many small business owners are first-time entrepreneurs which means that personal and business accounts can be confusing. However, mixing business and personal accounts for business transactions or funds can lead to cash flow management and tax issues. It is also important not to use your business credit card or debit card for personal expenses.
- It can affect taxes: According to the IRS, business owners can only deduct business expenses, so if you run your expenses through your personal bank account it will be hard for the IRS to determine if your business is a hobby or a company. This could open your business up to serious risks if audited.
- It can affect your credit score: Credit bureaus track your business’s credit much like a personal credit score. By keeping the accounts separate and paying bills on time, you can build your business credit. Using a business account for personal use or vice versa can reflect in your credit score.
Not managing cash flow
Operating a business comes with risk, but by managing cash flow closely you can plan better for the future. Cash flow management is the process of tracking how much money is going in and out of your business. By keeping an eye on cash flow, you can better manage your debts, like paying employees, suppliers and more. Many small business owners worry about amassing too much debt too quickly — here are a few common pitfalls that may contribute to this:
- Making large purchases for your business: If you’re looking to reinvest in your business, you may want to hold off on large purchases without projecting the potential ROI. Purchasing an espresso machine to serve customers coffee might bring in more revenue, for example, but it will also tie up your cash temporarily. You can maintain better control of your cash flow by being careful to not overspend on any unnecessary startup costs. As your business grows, you’ll be able to reinvest more and more into your business.
- Incurring credit card debt with the expectation of possible future revenue: Similarly, you may want to invest in marketing or inventory ahead of seasonal occurrences. But by making purchases with no guaranteed return on investment, you’re exposing your business to some risk.
- Not leaving any buffer room/emergency fund money: Having a certain amount of liquid cash set aside for emergencies can protect you against unexpected expenses. According to a 2016 J.P. Morgan Chase study, small businesses reserve about 27 cash buffer days. This means they have about 27 days of money as a buffer before running out.
Be aware of changing tax guidelines
Before you know it, the end of the year is already here and it is time to file taxes. When it comes to the end of the fiscal year, planning ahead can help you avoid a tax bill surprise. According to the IRS, a few common tax errors small businesses make include underpaying estimated taxes, depositing employment taxes, paying late, and not separating business and personal expenses.
- Planning for taxes as an employer: There are business entity types, like S-corporations and C-corporations, where small business owners can pay themselves as employees. In these cases, there are several taxes you will have to pay on your salary.
- Planning for taxes if you have employees: Employers should expect to deposit taxes they withhold. Another common tax mistake is misclassifying workers, so owners should make sure to file accordingly, classifying workers as contractors or full-time employees.
- Federal and state tax obligations: Federal taxes apply to all business owners, but state tax obligations vary by state. Filing taxes not only changes based on location, but by the type of business you are operating, which might be a sole proprietorship, LLC, C-corporation, or other entity type.
Failure to pay taxes properly results in penalties, so keeping track of taxes both quarterly and for the end of the fiscal year can help you avoid any tax surprises and having to consult a tax professional.
Lacking business insurance
Business insurance can help mitigate financial risk in unforeseen events. There are many different options when it comes to small business insurance. A few different types of business insurance to consider after speaking to an insurance provider, depending on the type of business you operate, are:
- Liability insurance (insurance that provides protection against claims from injuries and damage to property or people)
- Product liability insurance (insurance that protects a business from a product or service that causes injury or damage to third parties)
- Professional liability insurance (insurance that protects your business against negligence claims related to a professional service, also known as Errors and Omissions insurance)
- Commercial property insurance (insurance that covers your business’s physical assets from fire, explosions, theft, and more)
- Home-based business insurance (insurance that protects business assets, typically including business personal property and general liability coverage, often considered by self-employed professionals)
- Business owner’s policy (insurance designed for small and medium businesses that combines property and liability coverage)
Many small business owners have limited cash liquidity and irregular cash flow. The combination of a small cash buffer and irregular cash flow can contribute to financial issues. Employing some of these tools to avoid financial mistakes can help you better plan ahead and give you some room to make mistakes and cover unexpected expenses.