You work hard to make your business profitable. Obviously, you don't want to expose your company to unnecessary risks or jeopardize your personal assets. So let's review seven financial mistakes that are all too common.
Mistake 1: Mingling business and personal funds.
Some business owners fail to keep a separate bank account for their business and household. That can cause problems. Let's say you operate as a corporation or LLC. Having a single bank account is evidence that you're not treating the business as a separate entity. This creates an opening for a creditor to disregard the entity and get at your personal assets. Even if your business is a sole proprietorship or a partnership, it makes good sense to open a separate business account. If you don't, you'll have trouble knowing exactly how well your business is doing. And mixing business and personal funds can create a nightmare when you prepare tax returns.
Mistake 2: Putting personal assets at risk.
Doing business as a corporation or LLC limits your personal liability for business debts. In most cases, business creditors can't seize your home, car or personal investments if your business runs out of money. But if you're not careful, you may find that your personal assets are at risk anyhow. The following actions can be costly:
- Guaranteeing business debts and contracts. If your business borrows money, the lender may want you to personally guarantee repayment. And if your firm leases space, the landlord may ask you to personally guarantee that the rent will be paid. Going along with such requests puts your personal assets at risk. You may have no choice but to comply - but see if the bank, landlord or other creditor will agree to a cap on your personal liability.
- Putting your house on the line. Some creditors will want to place a lien on your house through a mortgage or deed of trust. Resist this. If your business goes bad, you don't want to sacrifice the roof over your head.
- Having your spouse co-sign. In many states, a creditor who gets a judgment against you can only go after your own personal assets - not the assets (such as a house) that you own jointly with your spouse. Knowing this, a creditor may want your spouse to join you in guaranteeing payment of a business obligation. Avoid this, if possible.
Mistake 3: Extending credit too freely.
Uncollected debts can hurt you. To avoid losses, require customers to pay cash or use a credit card. With a credit card, the bank takes the hit if the customer doesn't pay. If you do extend credit, first have the customer fill out a credit application. Then, especially for major purchases, get a credit report. Refuse to lend credit to deadbeats and slow payers. When you extend credit to a small corporation or LLC, have the owners personally guarantee the debt. (As you saw earlier, this can give you access to their personal assets if their business goes broke.)
Mistake 4: Paying your rent late.
If you don't pay your rent on time, the landlord may have grounds to evict you. This can be very disruptive. You can lose the advantage of a favorable lease or a top-notch location. Here's another reason to pay rent on time: Your lease may give you an option to extend your lease. Typically, to exercise your option, you have to be in good standing. Paying rent late can jeopardize your right to use the lease extension option.
Mistake 5: Winging it at a tax audit.
A small business is a prime target for an IRS audit. It pays to know the ropes before an audit begins. The IRS may conduct either an office audit or a field audit. In an office audit, you're asked to come to the IRS office. The audit lasts two to four hours. For a field audit, the auditors usually come to your place, though you may ask to meet elsewhere.
A field audit is more intensive than an office audit. The auditor will want to look at your business records: check registers, bank statements, canceled checks, receipts, invoices, and your accounting books. The auditor may also contact your tax preparer or bank for still more information.
You may be able to handle a routine office audit yourself. Still, you may be better off bringing in a tax professional, especially if your records are less complete than you'd like. And if you're subjected to a more intensive field audit where the stakes can be much higher, it's always a good idea to bring in a tax pro.
Well before the audit, be sure you can show how you came up with your numbers. Focus on any problem areas. Dig out the records you need to back up your tax return. It helps to have your data neatly organized; the auditor won't do the sorting out for you.
Mistake 6: Stalling on employment taxes.
As you know, you have to withhold income tax from an employee's paycheck, as well as Social Security and Medicare taxes. You then deposit these withheld amounts - plus the employer's share of Social Security and Medicare - with a bank.
If your business is in a cash bind, you may think about putting off the deposits. That can be dangerous. What if your business never recovers its financial footing? You can be personally liable for the undeposited amounts, and you can be hit with big penalties as well. Always deposit employment taxes before paying any other bills.
Mistake 7: Skimping on insurance.
For almost every business, insurance is a necessary expense. You can protect against many costly risks. You'll probably want property insurance in case your building, equipment and goods are damaged or destroyed by fire, flood or windstorm. And you'll want liability insurance in case a customer gets hurt while visiting your business.
Any business with employees needs Workers Compensation insurance. Also look into business interruption insurance. It pays for temporary quarters if a fire or other disaster forces you out of your normal business place. To save money, increase the deductibles. And look into insurance packages that bundle several coverages. A package can be cheaper than individual policies.