If you’re running a small business — even out of your home — you’re in good company: There has been steady growth in microbusinesses that operate beneath the threshold of $1 million in annual revenue — as well as a healthy rise in “solopreneurships.” The Small Business Administration reports that microbusinesses, which it defines as small businesses with one to nine employees, made up 75% of private-sector employers in 2016.1 Independent workers, including “gig” employees, make up some 41 million jobs and a third of the private workforce, according to 2017 research from MBO Partners.2

The allure of such businesses is obvious: Owners can focus on the niche that gives them a competitive edge and work on a schedule that fits their lifestyle. Yet starting a business, whether full time or part time, presents unique challenges. Many new entrepreneurs are not well-versed in business accounting, which can lead to unexpected cash crunches, poor vendor relationships or worse, such as costly tax errors. Plus, without an appropriate legal structure or process for separating business income and expenses from personal ones, owners may expose themselves to unnecessary liabilities.

Consider the experience of Katy Smith, who launched Stella Healthy Vending in Noblesville, Indiana, when she wanted to stay home after the birth of her first child. A former teacher, she carved out a niche market among local schools and leveraged her knowledge of the nutritional requirements established by the Healthy, Hunger-Free Kids Act of 2010. Since 2013, her company has deployed 26 vending machines in 15 locations across a 60-mile radius.

In a similar vein, Suzy Chang started Alfresco Booth (alfrescobooth.com), a mobile photo booth service, in Naperville, Illinois, in 2015. Chang’s mobile booths target corporate events and special occasion parties for those seeking photographic entertainment.  

While neither Smith nor Chang had launched a company before, each took the time to get advice from professionals and family members, who advised setting up as limited liability companies (LLCs) and opening business banking accounts distinct from their personal accounts. Smith and Chang also say they were careful to launch small and to grow by reinvesting profits into new equipment and marketing.

Uzma Kazmi, PNC senior vice president and business banking market manager, believes there are several reasons to establish a separate business entity with its own accounts.

The most important may be to offer an additional level of protection against liability, such as lawsuits, that could put your personal assets at risk. But having your business name on financial accounts and documents such as invoices also gives it legitimacy in the eyes of customers and suppliers.

Why You Should Create Financial Separation

For example, legal structures such as LLCs or subchapter S corporations (S corps) can create clear divisions while allowing owners to receive pass-through income from their profits. (Always consult a tax advisor or lawyer about which structure best meets your business’s needs.)

Maintaining separate financial records is imperative. Separate financial records will allow an owner to track business performance to make sure that customers pay on time and that expenses fuel — rather than eat away at — profit and growth. In addition, financial institutions and suppliers or vendors will want to see proper financial records before they will consider advancing credit to your business.

Ease of tax preparation is another reason to separate personal and business records. “A lot of sole proprietors have multiple sources of income, especially when they’re starting out,” Kazmi notes. “Mixing them can make tax time a nightmare.”

Establishing a business structure isn’t difficult or complicated, but it does require legwork. When Jaci Cox opened In His Time Books & Gifts in Crawfordsville, Indiana, in 2016, she immediately opened a business checking account and seeded her business with a personal loan.

Cox uses a popular accounting software program to manage her business account. She also creates spreadsheets to further segment her sales and compare performance across periods. “I’ve always been a stickler with numbers, even in my personal finances,” she says. “While I delegate other tasks, managing the financials is something I do myself.”

Five Steps for Startups

Here are the steps experts recommend when starting up a business entity

STEP 1: Plan for Growth

“I’m always amazed that people are willing to invest in a new venture without modeling out what the business might look like via a business plan,” says Kevin McQuillan, principal of The McQuillan Group (themcquillangroup.com), an accounting firm based in Pittsburgh.

What’s more, those who do create a business plan are often overly optimistic — particularly about underestimating overhead expenses. All ventures will have overhead, whether it’s a laptop, printer and home office space for consultants, or car maintenance and gasoline for taxi drivers.

“Understand that your cost structure will change with growth and that you’re likely to incur costs, such as inventory, equipment purchases, new hires and leases, before you see any resulting income,” McQuillan says. “Create a realistic business plan that projects six to 12 months outward, and make sure you have working capital to cover any shortfall.” Working capital, he explains, is cash on hand plus money you’re owed (accounts receivable) minus money you owe (accounts payable).

“Without adequate planning,” McQuillan notes, “when a company is on a growth trajectory, it can easily suffer a chronic cash shortfall.”

STEP 2: Make It Official

With plan in hand, owners should be at a point where they can choose the business designation they will use with the IRS and other taxing authorities. According to McQuillan, the simplest structure, sole proprietorship, doesn’t require an application, but it exposes personal assets to the greatest risk. Establishing an LLC offers greater protection, and a one-person organization might not need to file a separate tax return. An S corp offers still more liability protection but requires greater formality and more paperwork to maintain, as well as separate tax filings. Businesses must incorporate within a state first, after which they will apply for IRS recognition.

Each type of entity designation requires its own set of documents, but all require an Employer Identification Number (EIN) for tax purposes. Even if a business operates under a person’s name as a sole proprietorship, the company should apply to the IRS for an EIN so the company can be distinguished from the person’s Social Security number, McQuillan advises.

In addition, unless it is a sole proprietorship or a single-member LLC, a company will need its EIN to open a business checking or credit account at a bank. It should also follow up about the appropriate permits and licenses, which will vary depending on the business. Be sure to consult an accountant and an attorney to discuss the best option for your business.

STEP 3: Establish a Banking Relationship

The central financial hub for every company is a business checking account. This works similarly to personal checking, but it lists the company name and the owner. For those sole proprietors or sole members who have not attained an EIN yet and are doing business with a Social Security number, Kazmi recommends opening a separate business account to use exclusively for business transactions, which will help you maintain separate financial accounts.

Opening a business deposit account will enable you to invoice customers and request payments to your business name — for example, to Stella Healthy Vending versus Katy Smith. Business checking accounts may offer additional features and benefits over personal accounts. PNC’s business checking accounts, for example, offers an optional suite of online tools called Cash Flow Insight®.

The other must-have banking product, according to Kazmi, is a debit or credit card dedicated to business use. If your business is too new to qualify for a business credit card, consider dedicating a separate personal credit card for business charges. This will help categorize expenses, track spending and reconcile accounts each month, she says. Other considerations are credit card and electronic transaction processing, which can help make it easier for customers to pay you.

STEP 4: Adopt an Accounting System

To track your new business finances, adopt an accounting system that can categorize income, investments, expenses, assets, debt and owner equity (the money personally invested in the company). While checking and credit card statements provide details, using one of many popular software accounting programs can provide a more granular look at your total financial picture.

“At the very least, you need to record where your money is coming from and where it’s going,” McQuillan says, whether it’s generating from business income, loans or investments, or being allocated toward expenses, paying yourself or paying down debt. If you’re unfamiliar with the accounting tools on the market, McQuillan recommends working with your CPA, banker or a third-party vendor to evaluate system options and setup.

A good accounting system can also help an owner understand the profitability of products, services and projects, and it should allow the business to project cash balances down the line. And, of course, the system should help organize information to make it easy to prepare tax returns.

STEP 5: Monitor Results

No matter how advanced your accounting software, it will be helpful only if you regularly input transactions, reconcile accounts and monitor performance with tracking and reports. Depending on the size and scope of the business, you may have additional ongoing accounting requirements, such as tax filings and payments, payroll and debt maintenance.

“When I first started the business, I hired a bookkeeper but realized that managing and using my accounting system was easy enough to do myself,” Alfresco Booth’s Chang says.

Even if a business hires an outside bookkeeper or accountant to handle these activities, McQuillan recommends that the owner sign off on all the work and learn to read reports to understand the business’s financials. Many reports can give an owner deep insight. For example, Stella Healthy Vending’s Smith runs a profit and loss statement monthly, and she has linked her PNC business checking account to her QuickBooks accounting software to make reconciliation easier.

Here are the basic reports a business owner should review:

  • Balance sheet: This is a snapshot of assets and liabilities, including your cash, bank accounts, and the value of inventory and equipment minus debt and ownership equity.
  • Profit and loss statement: Your P&L is a summary of income and expenses over a defined period, which indicates the company’s profitability or “bottom line.”
  • Statement of cash flow: Often overlooked by new business owners but critically important, this report shows the movement of money into and out of a company’s accounts — income, expenses, investments and financing.
  • Accounts receivable aging: If you bill customers who pay later, the A/R report shows who owes what and when payments are due.
  • Accounts payable aging: Similarly, the A/P report indicates how much you owe vendors and when payments are due to them.

While managing your company’s financial accounts may not be the most exciting part of being a business owner, well-organized planning and administration can alert you to risks and opportunities. It will also provide the insights you need to continue pursuing the dream that inspired you to launch your business in the first place.

To learn more about how PNC can help you launch your small business on the right foot, visit pnc.com/startup.