FOUR NOT-SO-SEXY THINGS YOU NEED WHEN STARTING A SMALL BIZ.

Converting a hobby into a business requires hard work, time, and dedication but even more than that it requires a change in your thinking. Hobbies typically cost you money. Businesses make money (at least they should). There are four key areas where new business owners often falter when getting a new venture off the ground, all of which focus on treating your business as a business and not a hobby.  Here are four not-so-sexy but really important things you need do when starting your small business.

So, you are ready to take the leap and turn your creative endeavor into a business. Congratulations! Transitioning a hobby into a business is exciting (and scary). You are going for it – now what?

It can be really overwhelming to start a business. What should you do first? What are the most important tasks? There are the fun things to contemplate: your new business logo and branding, deciding where and how you will sell your products or services, and designing your website or online platform. There are also some not-as-exciting, behind-the-scenes steps that need to be taken as part of your new venture.

Converting a hobby into a business requires hard work, time, and dedication but even more than that it requires a change in your thinking. Hobbies typically cost you money. Businesses make money (at least they should). There are four key areas where new business owners often falter when getting a new venture off the ground, all of which focus on treating your business as a business and not a hobby.

Here are four not-so-sexy but really important things you need do when starting your small business.

Open a business checking account for your business

Establish a business checking account to be used only for your business. Opt for basic business checking (a free account with no monthly fees and no minimum balance requirement).

If your current bank doesn’t offer a free basic business checking account, shop around.

There are plenty of banks that offer free business checking. No need to pay unnecessary monthly fees, especially when you are just getting your business going.

If you are operating the business under a tax ID number other than your social security number, you’ll need to provide the tax ID to the bank to set up the account. Most banks will also require an initial deposit into the account ($100-$250) prior to activation.

The purpose of opening a separate bank account for your business is two-fold: to instill in you that this venture is a business and will be treated as such; and to simplify your business record keeping.

This account is only for your business activity. Income generated from your business is deposited in this account and business expenses are paid from the account.

Remember, only business expenses get paid from this account.

This account isn’t used to pay for groceries, your house mortgage, or daycare fees. Even if you use all the profits from your business to contribute to your household, run the income and expense through this account and then “pay yourself” out of the account to get the funds back in your personal account.

You may have times when your business isn’t generating enough revenue to cover all your expenses and you need to invest money in your business to keep sufficient funds in your business checking account.

In this case, you deposit funds from your personal account to the business account as an investment from the business owner. Then continue paying your business expenses out of the business account. No mixing business with pleasure – at least not in this context.

You’ll be surprised how much having a separate bank account changes your thinking about your business.

I’ve had a side gig for the last ten years, and for the first few years, I didn’t use a separate bank account for it. When I did open a separate bank account, my initial motivation was simply to make the record keeping easier.

I had no idea how much it would change the way I viewed my side hustle. It made me much more aware of how much income I was (or wasn’t) bringing in and helped me better evaluate and prioritize needs when it came to business expenses.

This new awareness prompted me to set bigger goals and focus on ways to grow and expand my side hustle. Powerful stuff. If you don’t have one yet, get a separate bank account for your business. You won’t regret it.

Select a system for tracking your income and expenses

Many businesses get their start as a hobby that grows and develops over time. We tend not to pay much attention to what we spend on the things we do for enjoyment.

My mom is a talented quilter with an impressive fabric stash accumulated over the years.  With a quick glance at her collection, she can tell you where and when she found each fabric, but not necessarily what it cost.

To be fair, quilting is a hobby for her and she doesn’t have any reason to keep track of those costs. When you are in business, recording and tracking the associated costs is important.

If your business has roots as a former hobby, you may be totally in the dark about how much it costs to create a piece of work or product that you intend to sell.

As you move from hobby to business, it is important to start tracking your expenses to get a handle on your costs. The sales prices you set for your work need to allow for profit (that’s why you are in business after all) and knowing your costs helps you do a better job of pricing your products and services.

Find a system of tracking income and expense that works for you.

When tax time rolls around, you will be glad you took this step. There are several small business bookkeeping software options available these days, many of which are cloud-based, allowing for secure data storage and user access across multiple devices. Three options to consider include Wave (free), Xero, or QuickBooks Online.

If bookkeeping software seems overwhelming, then start by using a spreadsheet or handwritten log – whatever works for you. The important part is to get started and get in the habit of tracking your income and expense.

You also need to keep receipts to support your business expense deductions. Electronic copies of receipts are fine, just be sure that your files are secure and backed up (not only stored on the hard drive of your computer).

If paper records are more your speed, set up a filing folder system to keep your sales invoices and expense receipts organized and accessible.

Understand your sales tax responsibilities

Sales tax is a state-managed tax collected by you from your customers (a tax added to the price of your products or services). You then remit the collected sales tax to your state department of revenue.  You are simply the middle man.

Since this is a tax paid by your customers, it is important to know your sales tax obligations before you make the sale or send an invoice. You don’t want to be in the position of having to go back to the customer to try to collect the tax after the sale or be forced to pay it out of your own pocket.

Sales tax obligations vary from state to state. It is really important to gain an understanding of whether the products and services you sell are subject to sales tax. In many states, certain services are now taxable, so this isn’t just a concern for product-based businesses.

Your state’s department of revenue website is a good resource to research sales tax implications for your business.

Typically, the state department of revenue site will have a vendor guide or getting started guide in the sales and use tax section of the site. If you get stuck or have questions, call and speak with someone at the department of revenue.

The employees are there to help you and generally are a great resource. Always make a note of the date of your call, name of the representative you chatted with, and the general topic of conversation so you can refer to it later or call again with a follow-up question.

The rules for sales tax are ever-changing, particularly with the growth of online commerce.

If your services or products are subject to sales tax in your location, make sure you stay current on sales tax responsibilities. Consider consulting with a CPA to ensure sales tax compliance.

Understand your federal and state income tax obligations

Transitioning from a hobby to a business also changes the IRS’s view of your activities. The IRS describes a hobby as an activity not engaged in for profit. You aren’t required to report hobby activities to the IRS.

However, business activities (activities engaged in with the intent and ability to make a profit) are of interest to the IRS. The IRS uses several factors to determine whether your venture is considered a business and those factors are beyond the scope of this post, but one key factor is profitability.

Once your business is earning a profit and you expect to owe at least $1,000 in federal income taxes for the year, you are required to pay quarterly estimated federal tax payments.

If your state has state income tax, you may also need to remit quarterly estimated tax payments to your state department of revenue.

Determining whether you need to make estimated tax payments and calculating the amount to be paid depends on your particular situation (your tax bracket, your anticipated business profits for the year, other sources of household income, taxes withheld on paychecks, etc.). 

Many new business owners get a really unwelcome surprise at the end of the year when they learn they owe several thousand dollars in taxes.

The good news in that scenario is you are running a profitable business, but if you don’t set aside money throughout the year to pay the income taxes, it can be a real challenge to scrape together the cash in one lump sum in April when filing your taxes.

For ease, many small business owners set aside a set percentage of their sales each month to cover income tax expense. The percentage to be set aside depends on your specific situation.

To keep it simple, deposit the funds in a separate savings account so you aren’t tempted to spend those dollars on something else. Once you’ve been in business for a while you’ll be better able to predict your net income for the year and that will help you refine your tax estimates.

Consider engaging a CPA to help you get a handle on your estimated tax payment obligations.

These four areas are the ones that commonly cause headaches for new business owners. Make the time to take care of these proactively and you’ll be setup for success. Then you can dive into the exciting and fun aspects of running your business without these pesky chores lurking in the background.

Action Item Checklist:
Open a business checking account for your business
Implement a system for tracking your business income and expenses
Understand your sales tax responsibilities
Understand your federal and state income tax obligations

The content in this post is provided for general information purposes. Readers should not act upon the content or information without first seeking appropriate professional advice about their specific situation.

 

Lesley Jeffres Pearson is a CPA with a full-time job as a Commercial Manager. She is the personal finance enthusiast, podcast junkie and numbers geek behind the blog, Stronger Wallet, where she helps people get a handle on their finances to achieve their financial goals. She and her husband live in Wyoming with their two young kids. Connect with her on Twitter or Facebook.