Scaling Accounting From 1


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My ruminations that would eventually become smiles+laughs company began in my Durham dorm room in Fall 2009. I was so focused on building the kind of job I would enjoy doing, and be proud of, that it’s fortunate it took roughly another year after graduation before the business began to produce meaningful income—because I would not have known what to do to keep the money legitimate and legal.

This is how we manage the money now, our “Accounting for Hackers”. It’s all bootstrapped, and a mix of income from our customer-delighting products like DropDAV and Time Card Vault, and our consultancy—we’re taking on new clients right now, so shoot Korey Tichenor an email to get started onboarding—which is a mix of fixed price and hourly jobs, almost all with a retainer paid up-front.

I am not a trained or professional accountant, or a lawyer. This really is how we do things, but you may want to do things differently. I’m happy to resolve any questions in the comments, to the best of my ability, but if this post whets your appetite and you want to work with a great accounting firm, I highly recommend Hymel & Ready—their advice has contributed thousands to our bottom line.

We’re organized as an S-Corporation, but this information might apply to LLCs too.

Accounting for Hackers

Last updated: September 2013

Bank Accounts

You want to have three bank accounts (“Incoming”, “Outgoing”, and “Savings”). One for Money That’s Yours, one for Money That’s Not Yours, and one for Money That Was or Will Be Yours. If you do things this way, checking your current cash position is as easy as logging into your online banking, and reading the balance of the money that’s yours account (roughly—you’ll probably have a credit card balance, but we’ll get to that later).

“Incoming” Checking — Money That’s Yours

This is your “runway”. You still need to keep future expenses in your head, but this way you only have one big pile of cash to do subtractions from. All deposits should land in this account—your Stripe transfers (you are using Stripe, aren’t you?), your PayPal Auto-Sweep transfers (you can make PayPal automatically empty your PayPal account into a checking account at the end of each day. Do this, do not trust PayPal!), and your physical checks (get a cool “For Deposit Only” stamp with this account’s number to feel extra official—we use one!) all come to this account first (transfer retainer payments to your savings account as soon as they clear). Money sits in this account until you spend it.

“Outgoing” Checking — Money That’s Not Yours

The checks you write, and the electronic balance transfers you create should originate from this account. This is the account number you have printed on your paper checks and share with businesses that need to draw on your accounts (your credit card companies, health insurance company, payroll processor, tax payment processor, etc.). Just before each time you write a check or create an electronic transfer, you move that amount of money from your “Incoming” account to your “Outgoing” account.

You need this account to compartmentalize legitimate (and non-legitimate, to some extent) claims on your cash. You ignore the account balance of your “Outgoing” account, because that money is already spent. You can confidently share your “Outgoing” account number without risking your entire cash pile, because any bad actors will only have access to steal the money you’ve set aside for payments. Sure, the people who you’ve agreed to pay that money to will be pissed when your checks bounce and transfers fail because thieves have cleared your account, but that would happen either way and at least in this case they won’t get all of your company’s money.

We don’t have our “Outgoing” account number printed on our business cards—we closely guard it—but we sleep a little easier knowing fewer folks have access to our “Incoming” account information, and our cash horde, by virtue of this compartmentalization.

“Savings” Savings — Other Peoples’ Money

Your business doesn’t have a savings account because your entire cash pile is in your “Incoming” account. However, every business has a float component to it, even if it’s just setting aside your payroll tax withholdings until the next monthly or quarterly payment. Every time we run a payroll, we transfer the post-tax money due to the payee into our “Outgoing” account, and the taxes calculated by our payroll processor (more on this later) into our “Savings” account. When the taxes come due, we transfer the amount of the payment from “Savings” to “Outgoing” just before approving the tax payment on our tax payment processor’s website (done through our payroll processor).

We also use this account to store retainer payments. We don’t treat retainers as our money because it’s not, yet. Once we’ve completed a segment of the project, we generate an invoice in Harvest, then draw the amount due from the retainer balance associated with the client in Harvest (which triggers a thank-you note in Harvest), and finally transfer the amount from “Savings” to “Incoming”. We’ve never had a client ask for a refund on their retainer payment, but knowing we could meet that demand without any financial hardship helps us rest easy.

Payroll

In the first year, people operating as one person entities (S-Corp or LLC) that spend their business income, calculate their taxes at the end of the year, and then stress out like crazy about how they’ll pay their tax bill. In the second year, they set aside whatever percentage of their income they paid in their first year, then reconcile that with their increased or decreased earnings. They plod on like this, living with huge uncertainty about what their exact tax burden is. And that sounds like a nightmare to me.

We started earning significant income in Spring 2011, and I didn’t spend a dime on personal activities. I was too scared I wouldn’t get the taxes correct, and I’d end up owing surprise back-taxes, interest, fees, and penalties to the government. I watched the money pile up in our business checking account for months before serendipitously meeting David Hymel after a tax incentives seminar at LaunchPad.

David’s a CPA/MBA, an entrepreneur, and a super sharp guy. I pitched my business income / tax burden dilemma to him and he knocked it out of the park: “Zane, set a salary for yourself and run payroll as if you are an employee of your business”.

Now we use Intuit’s “Enhanced” Payroll package ($28/month + $2/employee/month). Intuit’s conducts business in a fairly offensive manner, but their payroll web app is decently well designed and I trust their calculations to be correct. Their online payroll system handles all our compensation stuff—salary, bonus, pre-tax deductions (health insurance), federal taxes, state taxes, unemployment taxes, etc. We use it for our employees and contractors.

Each pay period, our employees get their post-tax compensation direct deposited in their bank accounts, and a PDF pay stub. When we run payroll, we transfer the post-tax income to our “Outgoing” bank account so it’s ready for withdrawal to direct deposit, and transfer the withheld taxes to our “Savings” account so it’ll be ready when we make our monthly (or quarterly) 940/941 payments. Our employees and partners can find their pay stub history using Intuit’s employee-facing payroll site. At the end of the year, everyone gets a W-2. Our shareholders use their W-2 to complete a 1040EZ for the extent of their personal income taxes. It’s simple and works very well.

There’s one hitch: any money left over in the business at the end of the year passes through to the shareholders as income. They pay taxes on that money even though we don’t disburse it to them. This is utter bullshit, but we’re not about to try to get the US tax code changed. Fortunately, the money’s on hand, so if the extra taxes are a hardship for a shareholder they could withdraw their share from the business to pay their tax bill. This part of the tax system is seriously shitty, but so it goes.

Business Expenses

As might have been betrayed by my discussion of payroll, I want to do nothing but copy some figures from one form to another come tax time. The idea of keeping receipts and deducting business expenses from my personal taxes is another nightmare. I want to spend the business’s money on business expenses, and be paid my money post-tax so I’m free to dispose of it as I please.

Our solution is to give all employees credit cards (we like American Express “Simply Cash”) for all and only business related expenses. Everything we need for business goes on these cards. All of our shareholders have one. All of our employees have one. We beg everyone to use the card to save themselves from needing to do the deduction math come tax time.

We’re a young organization, and this advice is meant for young organizations, but we’ve all heard about the traditional processes around employees doing expense reports. The idea of our people needing to spend their time tracking all of their expenses and receipts so that we can spend time reviewing them is (yawn) a nightmare. And it’s stupid to expect your customers to support the additional costs borne by lacking faith in your employees.

If you don’t think you can trust each of your employees to use their business credit cards intelligently, then you must fire those employees. Each moment your employee shows up on the clock they are spending the business’s cash. If they can’t handle the responsibility of a credit card, they can’t handle the responsibility of self-guided work.

Don’t go crazy “expensing” things. Be reasonable with what you charge on your business card. For example, we don’t expense food costs because we wouldn’t want our tax dollars to pay for government functionaries’ meals. You have principles in the work you do; have principles in what you “expense”—it’s what you’d want your compatriots to do.

Business Ledger (Suggested)

It’s a great business practice to prepare monthly Profit and Loss statements. They’re fairly straight forward to prepare using QuickBooks, or by hiring a contract bookkeeper or account. Since all of your business expenses are on your credit card statement, the bookkeeper just needs the credit card statement, your bank statements and your payroll records to put the P+Ls together.

Having P+Ls compiled contemporaneously, instead of preparing them retroactively whenever they’re called for, is a smart idea that often has legal ramifications. And if you’re ever seeking outside funding for your business, a clean set of P+Ls go a long way towards proving you have a good grasp on your business to potential investors.

Accountant (Optional)

In the end, if you have any cash coming in the door at all, it makes sense to have a working relationship with a smart accountant. An accountant that works mostly with businesses operating in your field will already know the best practices and the answers it would cost you valuable time to research. We’ve had a great experience with David Hymel at Hymel & Ready. If you’re in New Orleans, you’ll probably like him, too.

Questions? We’ll be in the comments to clear anything up you’re left wondering about.

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