Entrepreneurial Bookkeeping

Cash Flow and Profit

Cash flow describes the changes in the amount of cash in your business over time. As cash comes into and goes out of your business, cash flow is what we call those changes. Profit is the actual amount of money you make for a certain period of time after business expenses are accounted for. A lot of people talk about revenue without touching on profit, but a lot of businesses with high revenues aren’t profitable because their expenses are so high, so you want to make sure you get a clear sense of the profit too, not just revenue.

Note:  You can be profitable and still run out of cash if you don’t manage your cash flow.  We like to have a fixed amount of working capital in our accounts that we use as our “0”.  This means that we will never overdraft an account because more more happens to go out before more money comes in. As you watch your cash flow, decide on this amount for your business and always maintain a working capital cash flow to absorb any timing issues with cash flow.  We recommend you use actual cash instead of a line of credit for this purpose.

Emergency Funds

There are different places to draw security from in your business, but an emergency fund is something we’d highly recommend. This is an amount of cash that’s not earmarked for anything, just sitting in an account to be used when it’s needed in the event of an emergency. After paying off all your expenses, money should then be put into the fund to accrue over time. Up to 1–3 months of expenses is a good amount to keep for a rainy day, but everyone’s situation is different, so whatever feels right to you is fine.

Working Capital

The amount of cash you keep in your business should always be above a fixed amount of dollars, depending on your specific business and how much money you need to cover all of you regular expenses. This doesn’t count the emergency fund, which should be kept separate from this. Working capital is, at its simplest, what you have in your checking account. Having an amount of money in your account that doesn’t need constant monitoring is ideal. You can’t think of it as having more than zero. Brooke calls this “redefining zero”; pick an amount that you need at minimum to keep your business running and that will be your working capital minimum to cover expenses. Working capital is essentially a cash buffer that you will always have in your business to cover expenses.

Assets and Liabilities

These are things you own. In a cash based business, assets include the money in the bank or things that act as/can be easily converted into cash in your business. They are also things that directly make you more revenue, like equipment, programs, and employees. Liabilities are things that cost money without directly making you more.

The book Rich Dad Poor Dad, by Robert Kiyosaki, helped Brooke figure out some important differences between assets and liabilities. Expenses and whether debts are an expense is a common question. The key thing is that debt isn’t always good or bad, it really depends on how you use it. If you’re taking out loans to cover your expenses because you don’t have enough revenue, that might be a big problem. But if you take out a loan to invest in assets or give yourself a cash safety net during a growth period, that’s a much better reason and could help you in the long run. It’s also a good idea to pay off debt with assets first before going into loans for your liabilities.

Depreciation

A kind of non business expense, depreciation represents the loss of value in an asset, like a piece of equipment. Take, for example, a piece of equipment that costs $1 Million and has a 10 year operating life span. The equipment itself goes on to your balance sheet as an asset, but after 10 years, it’s effectively worth zero dollars as an asset as it can’t produce revenue for you anymore and will need to be replaced or abandoned. To measure this, we track its “depreciation” by $100k every year as an expense on your P&L. By doing this, we expense it over time instead of in one off million dollar expenses. Depreciation is rarely a problem in coaching businesses, but it’s still useful to know.

Business Entities

A “container” for your business, the business entity is basically the type of business you have. Which one you pick depends on what you want for legal and tax reasons. We talk about a few different ones throughout the course, so here are the basics below:

Sole proprietorship: An entity that allows a single person to run the entire company directly and doesn’t make any legal distinction between the person and the company. You are your company for legal and tax purposes.

LLC: An acronym, meaning Limited Liability Company. It is a flexible entity that’s popular for small businesses. It allows the owner some of the protection from liability that corporations get, while still allowing the owner to keep direct control. If, for example, someone wants to sue your business, it’s your business that’s responsible for that, not you yourself. If you’re making under $100k a year, this is the entity we recommend you use.

S corporations: Otherwise known as a closely held corporation, these are broken into a small number of shares and taxed through their owners instead of paying a separate tax for the company. S corporations do not pay income tax; instead the shareholders pay income tax themselves depending on their income from their shares. There are certain limits, such as the requirement that all shareholders have to be US citizens. If you’re making over $100k a year, this is the entity we recommend you use.

C corporations: A corporation that’s taxed separately from its owners. C corporations do pay income tax separately from their shareholders, which is why they’re sometimes described as being double taxed. They also don’t have the same limitations as S corporations do and generally have more shareholders.

Write Offs

Write offs are one of the most well known benefits of being in business for yourself. If something is a write off, it means that, when you buy it, it is tax deductible when you class it as a business expense. Remember, it’s your tax professional’s job to tell you what does and doesn’t count as a write off, so lean on them for that. A lot of business owners think of expenses in terms of what is and what isn’t tax deductible, but that’s not the best way to think about it. We don’t recommend you care too much about that, but instead focus on if your expenses are serving your business goals. Don’t just spend money because it’s a write off, stick to ones that actually serve your business.

Cash and Accrual Accounting

A lot of people in online industries talk about how well they’re doing based on how much they’ve sold. This is called the accrual accounting style, which means that you define your revenue by how many certifications or products you’ve sold, not on the amount of cash you’ve made. We HIGHLY recommend you use a cash accrual style instead, which focuses more on the actual money you’re making and, when we talk about numbers elsewhere in the course, this is the approach we’re using.

EBIDA

An acronym meaning Earnings Before Interest, Taxes, Depreciation and Amortization. It basically refers to your income before you account for interest payments, taxes, depreciation expenses, and amortization (which means the payments you make to repay debts, not including interest). This covers a lot of your biggest expenses. This used to be a popular way for people to figure out the health and growth of your business. It’s fallen out of fashion in the last 10 years and doesn’t really mean much for our purposes, but it’s still useful to know in case you ever come across it.

Estimated Taxes and Safe Harbor

Once you have started to earn a profit in your  business, you will start paying income taxes on that profit.  With your salary, your estimated taxes will be taken out through your payroll withholding.  With your profit income, you will need to do this manually. Each quarter, you will estimate what you will owe the IRS at the end of the year and pay an estimate directly to them.  At the end of the year the exact amount will be calculated and you will either owe more or get money back based on your estimate.  Safe Harbor is the amount you are required to pay in estimates this year based on your income the prior year.  Meet with your accountant quarterly to have them review your financials and estimate accurately.  Even if you aren’t required to pay the taxes now, make sure you keep an account of all taxes that will be due in April in a separate account.

Emergency Fund/Working Capital

We like having an amount we keep in the business for a cushion in case of an emergency or a cash flow issue. We call this our Working Capital or an Emergency Fund.  We highly recommend you follow our lead and always have saved at least two months of expenses to cover any unexpected needs for cash.  Do not rely on a line of credit for emergencies.  When you are in an emergency situation, the last thing you want to be doing is getting into debt.