Bootstrapping entrepreneurs often struggle with cash flow and attempt to lessen their financial burden by cutting corners wherever possible. One of the ways small business owners may try to do this is by understating revenues on their income tax return to decrease taxes and maximize on refunds. In fact, the IRS estimates that there is over $100 billion in unaccounted taxable business revenue generated in the United States each year. While on the surface underreporting your business income can seem inconsequential, this strategy can be a big mistake.
Business owners, no matter how small, must think about their long-term strategic plan. If you intend to pursue funding to grow and expand your business, float more inventory or to increase your advertising efforts, then you will need to prove consistent business operations over a period of time. Lenders and potential investors are very interested in learning about your ability to repay or generate a return on investment. Since it can be difficult for the self-employed person to prove business revenue, the income tax return becomes the primary proofing document. If you have understated your revenues, then you have not adequately reflected your business’ potential to sustain its operations.
If you plan to pursue funding in the next two to three years, start creating a verifiable record of income and expenses now. Credit card receipts, bank statements and income tax returns are all important documents entrepreneurs can use to provide proof of their business operations and potential growth. Here are a few things you can do to prepare proof of your business operations and financial standing.
- Implement an easy document management system to keep track of your reporting needs. Create both a manual, color-coded system for documents that need to be at your fingertips, and an electronic management system for backup and easy sharing or retrieval. There are many free and low-cost software applications available to help.
- Make sure to separate business financial documents from your personal documents to make for easier tracking of income and expenses. Designate specific credit cards and bank accounts for business purpose. Even if you are unable to immediately establish a business line of credit, dedicate one credit card for business use only.
- Pay yourself a salary rather than dipping into your capital reserves when needed. This is why it is important to have separate business and personal accounts. You can write a check from your business account and deposit it into your personal account as payroll. It can be easy to lose track of withdrawals without good documentation habits.
- Generate receipts and invoices to track when you pay-in capital from your pocket and reimburse yourself with cash as business revenue is earned. Just as you want to track when you pay yourself a salary, you also want to track when you personally cover business expenses This becomes especially important if you have formed your business under a legal structure meant to help protect your personal assets. Tracking business income and expenses separate from personal is your proof that your business is a separate legal entity.
- Accurately file your business income tax returns showing all true revenue and expenses. This not only establishes history of your business operations, but will also be your basis in making financial projections as well as identifying your business value if you decide to sell it down the line. Knowing what you expect to earn and spend over time will make it easier to manage and pay quarterly income taxes to the IRS.
Start laying a good foundation for your small business now by strategically planning to be prepared both financially and operationally for your future needs. You will find your entrepreneurial journey less stressful and easier to manage over the long haul. Don’t hang yourself by your bootstraps.