Episode Transcript
[00:00:00] INTRO: Welcome to Financial Snickens, your bite-sized information for entrepreneurs.
[00:00:12] Alisa McCabe: Today we're talking about the most common misunderstandings about your finances. Let me tell you. Tax time is really a stressful time for everyone, not just tax preparers or business owners. So we talk with so many business owners and the biggest pain points they have about their financials, and that just doesn't match what they're thinking should happen.
[00:00:37] If this is you, you are not alone. We often spend time with our clients talking about why the numbers that are recorded in a certain way that make sense accounting wise, but may not make sense until you get the proper explanation. And sometimes you need to hear this explanation more than once. So look, these are the top five questions that we hear from business owners, number one.
[00:01:02] I'm repaying a loan. It is taking a bunch of cash out of my bank account every month. How come? It's not an expense. Okay, I get it. Like you don't have money in your account and you're thinking, well, surely this is an expense to my company. I have to pay for this. But the deal is when you got the loan either for a vehicle or a building, or you just needed capital, you had the money to your bank account, and as you repay the money, You are giving back the bank most of the money that's already theirs.
[00:01:35] There are some that you give back that interest. So the interest on money that you loan from them, that is an expense. So if your loan payments $105 and $5 is the interest, a hundred dollars is recorded on your books at down payment, and that's gonna be on your balance sheet, not on your profit and loss.
[00:01:59] But the $5 is gonna be recorded as an expense on your business, which will lower your profit. So that's where the money's going and that's how it's being recorded. The second question we get a lot is, why do I show so much profit, but my bank balance is low? Where did all my money go? So there are multiple answers to this question, but I will give you the most common answers that we give.
[00:02:29] Look, your bank balance decreases when you pay the loan, which I just talked about, but it doesn't increase your expenses, and this means that more cash is going out of your business. So if you have a lot of loans, that eats up a lot of your cash, but it doesn't lower your profits. The same is true for owners' draw when you personally take money out of the business for personal expenses.
[00:02:58] That's completely fine to do, but it doesn't mean it's an expense to the business. It lowers the cash in the bank. It doesn't lower the profit. It doesn't increase your expenses. Now, if you don't bid into either one of those two categories where you have a lot of loans that you're paying and that's decreasing your cash, or you're taking sizable amount of money out of the business in a form of equity just to use personally, well, then you need to talk to somebody.
[00:03:26] Talk to your tax preparer, talk to us. Head over to our website. We can discuss it more. Take a look at your finances and dig down and find out why that's happening. Okay. Number three, what we just talked about, why isn't the owner's draw an expense? So the owner's draw is when the owner, again, takes money out of business for personal use.
[00:03:50] This money can be used for anything the owner wants. It's not an expense to the company because the money has not been used for an expense associated with the business. The owner can take a salary for payroll. That is a bus that is an expense to the business, but only S Corp and C Corp can have the owner on payroll.
[00:04:13] Sole proprietors and L L C owners can take distributions from the business in the form of owner's draw. So again, this is why it's really important to know what type of entity you are so you can record and understand how you as the owner can take money out of the business. Okay, number four, big question.
[00:04:36] Would I pay income tax on my business profit? Why aren't they an expense to the business? Why aren't I looking at it and seeing it in my expense column? Well, again, depends on what your entity structure is. Again, it's why it's important to know, are you a sole proprietor? Are you an L L C? Are you an S-corp or a C-corp?
[00:05:01] So sole proprietors, LLCs, and S-Corp are all considered flow through entities, which means that the profit flows through to the owner's tax return. All of it. The downside is that you have to pay tax on it, but on a good note, you're making a profit. The tax payment comes from the owner and not the entity as it is considered income personally to the owner.
[00:05:28] Now, C Corp, which are the big corporations, pay taxes on the profit of the company and it is an expense to the company. For more details or information you need to talk to your tax preparer. They can help you decide what is the best entity for you. Dependent on what your tax position is, what are your profits this year versus what they were the year before?
[00:05:55] They may suggest you make a change in how your taxes are treated. So this is the big one. Number five, I felt blindsided by my tax bill this year. How much should I set aside for taxes? Man, this is the worst feeling you have, you have a great year and you're doing good. And all of a sudden your accountant says you owe a boatload of cash to the i r s.
[00:06:21] Okay, we're failing. Let's avoid it. You need to ask your tax professional for more information about this, but in our experience, if you keep aside about 30% of your profit for taxes, You'll be prepared to pay taxes when the time comes. You can also make quarterly estimated tax payments, and this is a pay as you go, and the IRS strongly recommends this.
[00:06:47] Again, these five things that I've talked about here are the most common misunderstandings. If you wanna talk more about any of these things or learn more about how to understand your financials and your business, Head over to our website, firststepsfinancial.com. Click on the Let's Chat button and we can talk more about how to understand your finances and maybe even find a really good tax preparer to help you.
