Shark Tank Jump Start Your Business: How to Launch and Grow a Business from Concept to Cash (10 page)

Growing up, I wanted to be a photographer, but my father pointed out that it was going to be a very difficult way to make a living. Of course he was right, and ultimately I chose to go down a different professional path. But I believe being a great businessperson is half about being a great artist.

Today I’m still an avid photographer, and I can afford to buy the best equipment and travel the world taking images. In fact, I have my very first exhibit next month. And the only reason I can do any of this is because I’ve chosen a career that allows for it. That’s what being an entrepreneur is all about: achieving financial freedom.

If you’re going to be an entrepreneur, you must understand one thing: business is war. It’s black or white; there’s no gray. You’re either making money or you’re losing it. Admitting that truth can sometimes be politically embarrassing, but it’s the only reason ever to go into business. You also must understand that it’s a process—a tide that goes in and out. I’ve lost millions, and I’ve made millions. What’s important is that at
the end of it all you come out on top—that you’re able to provide for your family and do with your time what you wish.

I’ve waited my whole life to be a photographer, and the only reason I can do it today is because I’ve achieved financial freedom. It’s really the American Dream.

When you’re first starting out, spending a lot time analyzing your finances isn’t the easiest thing to do, mainly because there isn’t that much to analyze. It’s a lot simpler to ignore a negative balance or look past a missed payment for the sake of mental ease. But that’s a habit you literally can’t afford to get into.

Like most entrepreneurs, you probably started your business to solve a problem, gain independence, or follow a passion. Unless you’re a financial professional by trade, chances are your motive wasn’t to become an accountant. That’s okay. Being great at numbers isn’t a requirement for being an entrepreneur. You must, however, have a decent understanding of
certain
numbers that will affect the daily life of your business.

Think of your financial health like your physical health: the more information you have, the better prepared you’ll be for the future. Although it’s tempting to outsource all of your financial tasks to a professional, there are certain fundamentals that every small business owner must understand in order to run a successful business, especially if this is your first time starting one.

Step one is to decide which accounting method you’ll use to track your financial progress: cash or accrual. While the cash method is the more utilized choice, certain operations may be served better by using the accrual method.

Cash:
Under the cash method, revenue isn’t recorded until the cash is actually received. Similarly, expenses aren’t accounted for until they are actually paid. EXAMPLE: You run a small janitorial business and signed on a new corporate client in March. You give them ninety days to pay their invoice and you deposit the check in June. Under this method, the revenue would be recorded in June, not March.

Accrual:
Under the accrual method, revenue is recorded when the order occurs or the service is provided, not when the payment is actually received. Likewise, using this method, expenses are accounted for when they are incurred, not when they are paid. EXAMPLE: You purchase a new copy machine in July and have six months to pay the manufacturer. Even if you don’t pay the bill until January of the following year, under this method you would record the expense in July.

After learning more about each method, it’s easy to understand why most small businesses prefer the cash method: it gives a real-time picture of the company’s finances and allows them to see how much money they actually have available. However, by providing a more accurate long-term projection, the accrual method can be a better choice for certain types of organizations. What’s more, if your business has sales over $5 million per year or sells inventory to the public (with sales grossing over $1 million per year), you don’t have a say in the matter; you are legally required to use the accrual method.

Make sure to consider how your chosen accounting method will affect your business at tax time. If you’re using the accrual method, for instance, the expenses you incur in one
year may not be deductible until the following, depending on when the payment was actually made. Let’s use the copy machine example from above. Although you ordered the machine in July 2012, you didn’t actually pay the invoice until January 2013. Therefore, under the accrual method you would declare the deduction in the latter year instead of the former, even though you recorded the expense in your own accounting in the first year.

Once you’ve chosen your preferred accounting method, the next step is to develop a solid financial management process. If you’re a new entrepreneur and not familiar with basic accounting principles, just the phrase “financial management process” may be enough to send you rushing off to the next chapter. Don’t let it! While accounting can be overwhelming at first, it’s a vital part of being a responsible business owner and can often be the difference between success and failure. From anticipating pitfalls to projecting growth, a strong financial management process is essential to the overall sustainability of your business. Here are a few tasks every business should practice:

Keep receipts and invoices:
You’ll want to get in the habit of keeping exceptional records right from the start. This includes everything from collecting expense receipts to tracking supplier and client invoices. For some businesses, this might be a daily task—think retail—while others might only need to do it every few weeks. While the record-keeping process ranges greatly in time and complexity, for many companies it shouldn’t take more than a few minutes each day.

Record information:
A filing cabinet full of crumpled receipts and invoices won’t do you much good. If you’ve taken the time to save records, you might as well devote some additional energy to organizing and entering them in a centralized database.
Before the rise of technology, many business owners managed their books by hand in a ledger. Today, there is a wide variety of software, apps, and online tools that help companies track and organize records efficiently. While very small operations may be able to manage their bookkeeping process on a standard spreadsheet, most businesses will require specialized software or online tools, like QuickBooks or FreshBooks. Whatever program you use, be sure to enter your income and expenses regularly and thoroughly. You’ll need all of that information to run proper financial statements.

Produce financial statements:
Preparing and reviewing financial statements is pivotal to the long-term health of your business. Luckily, creating these necessary reports is simple if you’re keeping accurate records and recording them with basic bookkeeping software. Financial statements are valuable because they provide you with a real-time snapshot of how your company is performing. Moreover, they answer important questions like: Are you generating enough income to cover your expenses? Is that income coming in fast enough to pay your bills on time? Is your company growing from month to month? For a new business owner these questions are crucial, especially during the startup phase. Depending on your chosen bookkeeping software, you will have access to a variety of different financial statements at the push of a button, but here are the three you should run on a regular basis:

Profit and loss statement:
Commonly referred to as a P&L, this vital income statement does exactly what it sounds like: tracks how much profit or loss your business has experienced over a specified period of time, be that a week, month, or year. It also allows you to see your net income and, depending on your accounting software’s capabilities, which products or
services are performing better—and where you’re overspending. Most businesses choose to run a P&L report on a weekly or monthly basis.

Balance sheet:
This report provides a snapshot of your company’s overall financial position. In essence, it tells you what you
own
and what you
owe
, allowing you to see an accurate picture of your assets and liabilities. It’s this statement that also reveals your net worth (also referred to as “net value” or “equity”). This is a critical document when trying to secure an investment or loan. If you’re a regular
Shark Tank
viewer, then you already know how important this document is to your business. Without a balance sheet, an entrepreneur would never be able to identify her company’s actual worth, thus providing no accurate basis for a valuation.

Cash flow statement:
Running a business can be expensive. The cash flow statement allows you to see how much cash you’re bringing in at any given moment and tells you whether you have enough money to cover your expenses. Because, as it turns out, even profitable companies are not always able to pay their bills on time. Let’s say, for instance, that you’ve brought in $100,000 of new business from four customers who have been given ninety days to pay their invoice. At the same time, however, you are required to pay
your
bills within thirty days. Even though your business is making a profit, you’ll still struggle to cover your bills each month if the cash is taking ninety days to actually come in-house. The cash flow statement allows you to identify this information in advance, so you can plan appropriately.

If you have little to no experience with accounting, this probably seems like a lot of information. In fact, it may be helpful to read this section over a couple times. While you will most likely hire an accountant or bookkeeper at some point,
as the founder it’s your responsibility to have, at the very least, a basic understanding of accounting principles.

Survey a hundred entrepreneurs on their favorite part of running a business, and you’re likely to hear a range of inspired answers. From the excitement of tackling daily challenges to the pride that comes with financial independence, owning a business has plenty of perks. But one thing you probably won’t hear an entrepreneur rave about is paying taxes.

As the saying goes, “Nothing is certain but death and taxes,” and for the small business owner this couldn’t be more accurate. Without fail, each year the federal and local government will come knocking on your door in search of their piece of the pie. From individual and corporate income to payroll and sales, you can rest assured that anything that can be taxed will be taxed.

Of course the best way to grow your income without owing the government an arm and a leg is to claim legitimate deductions from your business expenses. But it’s not always as easy as it sounds. Most people are under the false impression that once you become a business owner, pretty much every
expense is tax-deductible. Unfortunately it’s a little more complicated than that.

According to the IRS, only “ordinary and necessary” expenses can be deducted from your business income, including such things as supplies, insurance, rent, and equipment.
While you can also deduct items like entertainment, travel, and vehicle expenses, those fall under different rules, and are often only partially deductible.

While calculating your deductions, there are two primary types of expenses to understand: current and capital. Current expenses are incurred on a daily basis and can include everything from rent to travel. Capital expenses, also referred to as “business assets,” are generally larger purchases that have a life of at least one year. This type of expense cannot be fully deducted in the year it occurs, and instead must be spread out over the life of the object. Let’s say, for instance, that you purchased a piece of machinery for your T-shirt business. Because that equipment would be used over the course of many years, it would be considered a capital expense.

Deductions are vital to the prosperity of your business and should be recorded accurately and honestly. If you’ve been diligent with your accounting throughout the year, this should be a fairly manageable process.

Once you’ve figured out your deductions, it’s time to sit down and tally up how much you’ll owe. Depending on your location, incorporation structure, and type of business, you will likely be subject to three different types of taxes: federal, state, and city or county. There are a number of factors that affect your specific tax requirements, so it’s best to consult with the appropriate government agencies.
Below, however, you’ll find a generalized breakdown of the types of taxes you can expect to pay:

Sole proprietors:
As you learned in the previous chapter, under this legal structure, income from your business is treated as personal income. Along with the standard form 1040, which shows how much money you’ve earned, you must also declare your company’s profit on a Schedule C and pay self-employment taxes, which is reported on Schedule SE. Currently, the self-employment tax rate is 15.3 percent, which goes toward Social Security and Medicare.

Partnerships:
Similar to sole proprietors, partners are taxed, not the partnership itself. That said, partnerships still must report income and losses each year. While partnerships must also pay income and self-employment taxes, a partner can deduct half of the self-employment tax at the end of the year.

LLCs:
Just as with sole proprietors and partnerships, under an LLC, income is taxed to the owner, not the business itself. While you must pay self-employment tax under an LLC, you need only report income and losses to the IRS if you have more than two members. Although the IRS does not tax LLCs, certain states may require additional taxes to be paid, which can range in size. Most LLCs can incorporate in any state, so it may be in your best interest to explore options outside of your current home state. Similar to how many corporations choose to incorporate in Delaware, many small businesses prefer Wyoming and Nevada for tax and protection reasons.