11 Financial Mistakes – Part 2

By Trishan Arul    October 28, 2009

This is Part 2 of my post on Top 11 Mistakes that Ruin Entrepreneurs. Part 1 covered the first five items. “Ruin” may be overly dramatic but even businesses with solid underlying fundamentals can be ruined if you make enough of these mistakes.

6. Creating the wrong business structure – One of the first things you should do is to determine what business structure you need. Common choices are: sole proprietorship, partnership, LLC, and Corporation (both S-corp and C-corp). Take into consideration compliance work, cost, legal liability, employee issues, and taxation. There is no right form of business for every startup. In most cases you can switch forms down the road but the hassle and costs can be significant. I’ve spoken with many entrepreneurs who have spent thousands of scarce dollars to form a corporation which they didn’t need. This is a huge topic which I will address in the future but some resources can be found at my colleague Richard Greenberg’s Seedport website – he does that stuff for a living so if you want help, I recommend him!

7. Having employees without realizing it – Despite what some people say, there is no black & white line between being an employee and a contractor. The IRS provides some general information and even has Publication 1779 devoted to the topic. In general, the more control the business exerts over the work and finances of the person, the more likely they are to be classified as an employee. Penalties for incorrectly classifying an employee as a contractor are severe: the employer has to pay all of the payroll taxes (employer & employee portions), all of the income taxes that should have been withheld, and penalties. That can add up to 50% or more of what you paid the person. While classifying someone as a contractor may seem easy, it could cost you dearly down the road. Payroll is a huge headache which most people try to avoid but there are many inexpensive payroll solutions which can make it painless. So, no more excuses not to do it right.

8. Not opening business accounts – This ties in with #5 in Part 1 about Mixing Personal & Business Funds. At a minimum, you should have a separate bank account and credit card for your business. Most likely, you will have to personally guarantee the credit card but that shouldn’t prevent you from opening the account. Not only does it help you to separate business from personal transactions, it also allows your business to build a credit history. That will be important as you try to open accounts with various vendors for office supplies, cell phone service, computers, etc. Whenever you have the option, open an account under the name of the business so that when you need credit it will be available.

9. Funding the business with credit cards – Even after Congress acted to ban the most blatant abuses of the credit card industry, they are still a double edged sword. Credit cards are useful and often necessary to make many regular purchases, especially online but they also offer very expensive credit which is all too easy to abuse. If someone offer to lend you money at 20% interest, you’d probably consider that loan shark rates and immediately turn them down. Yet many small business owners pay more than that to their credit card companies without even thinking about it. Usually it starts out with small balances carried over so that you can meet payroll or conserve cash. But very quickly people end up reaching their limit, unable to pay off the balance, rolling it over month after month, and transferring balances to other cards. And when you depend on the credit card, it can really hurt if it gets cut off as many entrepreneurs have recently discovered.

10. Accounting without a shoebox – Handling your business finances with a shoebox isn’t recommended either! But many entrepreneurs don’t even bother to collect receipts, bills, statements, etc. in one place. They just ignore the accounting and money side of the business because its a hassle and there are so many other things to get done. Plus most people don’t like accounting so they avoid it as much as possible. Aside from never really knowing where your business stands financially, you will eventually have to figure it out. And when you finally try, it will be the nightmare you were dreading – we routinely spend months with new clients just trying to sort out their historical finances. If you’re separating your finances (Item #5) and keeping separate accounts (Item #8), then accounting doesn’t have to be difficult. Sign up for some of the free online services to make your life easier. Some websites that I recommend are Outright (which is designed with businesses in mind and can even sort expenditures by tax line) and Mint (which is geared to individuals but the importing and classifying features are great).  And if your business is large enough, then consider hiring a professional to handle the accounting – a good accountant will not only keep your books in order but they will become a financial partner and trusted advisor helping with many other business matters.

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11. Not paying your taxes - I had a tax professor in university who used to say that you always have to pay your business partner… the government! Unfortunately, its true. This may seem simple but there are many layers of taxes that need to be paid: local property taxes, local payroll taxes, withholding taxes, FICA, income tax, etc. Its not uncommon to find businesses operating on a shoestring who decide not to pay some or all of them. This can lead to significant penalties down the road. One popular misconception is that you only have to pay income tax when you file your tax return. In reality, everyone has to pay income taxes throughout the year – employees get taxes withheld from paychecks but businesses need to make quarterly estimated tax payments. If you fail to pay the lesser of 90% of the taxes due or 100% of the prior year taxes by December 31, then you can be assessed penalties. And if you handle your own payroll, not remitting payroll taxes (employee withholding) is a serious crime with penalties to the INDIVIDUALS responsible (yes, even if it was a corporation) of up to 100%. Like credit cards, many businesses fall behind and think they will make it up later. If your business can’t afford to pay its taxes when due, you need to take drastic action now.

I’ve seen these mistakes made countless times by generally smart individuals. Avoiding these mistakes won’t necessarily make you successful but it will create a solid financial foundation for your business. Now, if you do end up making any of these mistakes, just don’t tell people you read our blog!