Anyone building a business from the ground up has their hands in more things than they want—at first. New entrepreneurs lean heavily on strengths to disguise other weaknesses. If financial management isn’t one of your strengths, then you’ve probably considered hiring an accountant. But do you know enough to get the best results from their work?
Our Finance Friday Co-working Sessions are an opportunity for us to review the financial essentials for tax prep season and other number-oriented knowledge. Tax literacy—understanding taxable income, expenses, cash flow tracking, hiring accountants—will help you get the most from your business. If you do hire an accountant, your tax literacy helps them do the best work for you.
Be Tax Literate
Understanding taxes keeps you free of the IRS, and also puts you in a position to more effectively manage your money.
Revenue and taxable income are different.
Revenue (gross revenue specifically) is the total amount of income generated by your business prior to taxes. Your gross revenue is not all taxable income. Let’s use familiar tax forms to unpack this difference.
Remember that feeling when your first check was smaller than you expected after multiplying your rate and your hours? Payroll services automatically deduct taxes from your paycheck (e.g., federal, state, and local personal income tax, social security, FICA, Medicaid, etc.) and submit these taxes to the government through the year on your behalf. A W-2 is the report you receive at the end of the year breaking this down.
If a US company pays an independent contractor more than $600 in a year, they are required by law to file a 1099 with the IRS. If you’ve received a 1099, your payments have been reported to the IRS, and the IRS expects you to claim this on your tax return. Unlike a W-2, the company that paid you as an independent contractor is not required to submit tax payments on your behalf. It is your responsibility to pay this tax.
As a self-employed person or a business owner, expenses help to offset your tax liability. This is the important difference between revenue and taxable income. Many expenses from your work are not subject to tax. They are, literally, “the cost of doing business.”
Your taxable income is your gross revenue minus any qualified expenses and deductions.
(Good) Money Management Makes Money
Identifying and categorizing business expenses is fundamental to good financial management in every business. Every major corporation’s financial management needs are different, as is every self-employed person or small business owner.
The key is choosing the right tools (or professionals) that fit your business. The first step toward effective money management business owners must take is separating business and personal finances. This is important for practical and legal reasons.
When you stop identifying your work as a side hustle or hobby and start identifying it as a business, this mental shift has practical implications. When your work is a business, rather than a hobby, revenue and expenses are easier to compartmentalize and organize. This makes us critically evaluate the sustainability of our creative enterprise and hopefully points to ways we can make it more sustainable.
Separating business from personal finances has important legal and tax implications. A business’s formal, legal structure can affect its tax obligations. Creating a legal entity for your business has the added benefit of making it more practical to further separate business and personal finances. As a legal entity, your business can open checking accounts, directly pay for its expenses, and pay you an income.
Separating your business and personal finances, and tracking them thoroughly requires diligence. Luckily, there are more accessible accounting solutions for growing a business than ever before. Everyone’s needs will be different, but the goals are the same: track financial activities, categorizing revenues and expenses.
QuickBooks is one well-known software solution. One of its major benefits is its familiarity to most—if not all—financial professionals. If you’re going to do your own bookkeeping, consider shopping around for other solutions that fit your needs. If you’re going to hire a professional to do your taxes, consider what software solutions they prefer and what they’ve had success with.
Welcome Outside Support
The value of establishing a relationship with a financial professional is not just about making taxes easier—although it can do that. It also is an investment in your ongoing financial health. An outside perspective can help you see things you couldn’t before in your own creative work. The same is true for your business—a financial professional who has strengths you might not can only strengthen your vision.
If it’s not a professional, then consider leveraging your network of peers to seek guidance. Everyone’s situation is different, but we all seek financial security and sustainable, rewarding livelihoods.
Ideally, our co-working sessions provide these opportunities to extend your network of professionals and successful peers. If you are someone who prides yourself on financial literacy, you can be an important resource for others. Cultivating these skills within our creative industry will help bring art and beauty to the world. A co-working session is a great starting point, but ultimately, sound financial management will need to be a cornerstone of your success.