Becoming Your Own Boss (BYOB, 6.0)

In the first series, Becoming Your Own Boss (BYOB, 1.x) "Introduction, Today's Employment Picture", you learned some of the facts related to the current employment picture and examined some of the choices that were available to you. In the second series, Becoming Your Own Boss (BYOB, 2.x) "Examining Your Situation", you answered some key questions to figure out if starting as an independent contractor was a good idea for you. In the third series, Becoming Your Own Boss (BYOB, 3.x) "Preparing for Business", you examined the numerous topics (from taxes and insurance to your need for equipment and an office) that need to be considered before you take the step to establishing an independent contracting business. In the fourth series, Becoming Your Own Boss (BYOB, 4.x) "Establishing Your Business" you learned the many requirements involved in operating a business from the business name and structure to the business forms you will need once you establish your business. In the fifth series, Becoming Your Own Boss (BYOB, 5.x) "Marketing Your Services" you learned many of the aspects of the critical subject of marketing your services as an independent contractor.

In this article you learn about the topic of bookkeeping and several options you can use to keep the books for your independent contracting business. Bookkeeping is a necessary evil. Bank and charge accounts are also necessary evils. Good business practices suggest that it is prudent to know your financial condition at all times, but the reports and returns associated with federal and state taxes make it mandatory. It's all rather depressing.

Bookkeeping

For the independent contractor who operates as either a sole proprietorship or a single-person corporation, there are three relatively practical methods of bookkeeping: 1) manual, 2) computerized accounting programs, and 3) bookkeeping services. Actually, two of these are practical, the other is really not.

Manual Bookkeeping: Manual bookkeeping for most people is a matter of keeping a checkbook record and a box of receipts. This method seems like a reasonable solution for people who are not in business, except at tax return time. Then, there is the painful process of reconciling the checkbook record, the receipts, and the items for which there are no receipts; and there is the hope that the Internal Revenue Service will not call for an audit. At tax time, it becomes clear that something more efficient and effective is required. Unfortunately, most people forget the pain soon after April 15th and stumble on, disregarding the almost criminal ineptitude of the people who write tax laws in the U.S. Congress and the certainty that the process will be more complex next year.

For the business person, a more formal process is an absolute requirement, particularly if there are multiple clients and purchases, and perhaps even subcontractors. This process entails actually making entries in a book, using a ten-key calculator, and exercising the brain in an unaccustomed manner. At that point, most people seek help, or take a course or two in bookkeeping. It gets rather complicated, and it seems to be incredibly time consuming and frustrating. The manual method might be appropriate for the short term, but it is definitely not satisfactory for the long term.

Bookkeeping/Accounting Programs: If you wish to do it yourself for your business, the next step then is to a computerized accounting system. There is a fairly broad selection of very good and relatively inexpensive programs available that run on a personal computer and that are aimed toward the individual and the small business. Quicken and Quickbooks are two of the applications that come to mind immediately. There are others. All are relatively simple to operate and will provide your accounting information in a form very usable for records and tax return preparation purposes.

For example, some programs offer general ledger, accounts receivable, accounts payable, inventory control, billing, purchasing, budgeting, and auditing modules. Such features will do much more than just help you to keep your checkbook record current. With the programs that offer a check writing feature (most do), you can purchase blank checks with only the Magnetic Ink Character Recognition (MICR) information preprinted. Then you can use your program to print your logo and company name, payee, amount, et cetera; which will produce very impressive, professional appearing, and business-like checks.

If you prepare your own tax returns (not recommended), the information supplied by any of these programs will make your life easier. If you use a tax accountant, he or she will thank you for the rational presentation. And your tax preparation expenses will be less than if you do your bookkeeping manually.

We can recount two sets of experiences. One contractor has used Quicken for several years; another has used the shoe-box method. The one who uses Quicken is merely displeased and disgusted with the bite of the federal and state bureaucracies at tax time; the stubborn one, who uses the shoe-box method, is usually stunned at tax time. Incidentally, the stubborn one has finally seen the light and recently purchased Quicken.

Bookkeeping Services: If you find the idea of keeping your own books intimidating, you can contract for bookkeeping services. Just "let your fingers do the walking" or use an on-line search tool. Such services are not exactly cheap, but a good service can keep you from making mistakes that invite audit by the IRS. (Just remember that a bookkeeping service cannot do your tax planning. For that, you need an accountant who is a tax specialist.)

However, if you are reasonably computer literate and you are not intimidated by a bit of simple math, contracting for bookkeeping service is not very cost effective. A computerized accounting package is a much better choice.

Expense Records: Careful and accurate records of your expenses are very important for tax purposes. If you use the manual method, something other than a shoe box is required. If you use an accounting program or a bookkeeping service, most of the solutions to the problems are presented in such a fashion that you are encouraged to keep good records. Expense records are divided into the following classes:

NOTE: In general, it is better not to pay in cash for any business activity. A check or a credit card receipt provides not only proof of the expenditure, but also provides space for notes about the nature of the expense.

1. Mileage Expenses - Keep a mileage log on the vehicle that you use for business transportation, and keep it up to date. (The Internal Revenue Service rules are very specific on this point, and, if you are audited, it is one of the points that will almost certainly be checked.) This log may be on your computer, but it must be kept up to date. If you use a vehicle that is owned or leased by your business, and you do not use it for private purposes, all of the expenses for that vehicle are deductible as business expenses. If you use your personal vehicle for business transportation, you may reimburse your personal account for mileage from your business account at the current mileage rate allowed by tax rules. (Check with your tax accountant for the current rate.) If you do this, you need not pay withholding and self-employment tax on the full amount, and you may use that amount as a business tax deduction.

2. Other Travel Expenses - Keep records of all business travel by means other than your private or business vehicle, noting who, when, where, and for what purpose. If you travel to distant places for business calls, and the travel costs are substantial, the accuracy of these records is even more important.

3. Telephone Expenses - If your office is located away from your home, and you have a business telephone in that office, the service charges and toll expenses for that telephone are legitimate business expenses and are entirely deductible. If your office is in your home, and you pay for your telephone from your personal account, part of that telephone expense is also a legitimate business expense and is deductible. When you receive your telephone bill each month, compare it with your telephone log, mark each business call, and record the business total. You may then reimburse your personal account for those business calls and not pay withholding and self-employment tax on that amount. Keep the telephone bills as parts of your tax records. If you keep the bills as parts of your personal tax records, make certain that these are available in the event of a business tax audit, and vice versa.

4. Miscellaneous Business Expenses - Keep receipts on everything that you purchase for the business. This includes all work supplies as well as capital equipment. Do not overlook any items, no matter how small. Even paper clips and rubber bands add to your expense load, so take all of the tax advantage that you can.

5. Entertainment Expenses - Keep very good records on business meals and other entertainment expenses, noting who, when, where, and for what purpose. Ask for a receipt at each expenditure and note the circumstances on or with the receipt. Entertainment expenses are almost always scrutinized by the Internal Revenue Service. Talk with your tax accountant so that you understand the rules before incurring significant entertainment expenses.

The next article in this series (BYOB, 6.1) discusses the various kinds of business bank accounts (Checking/Debit/Savings/Charge) you need to establish, and concludes by discussing taxes and the tax planning you need to perform for your business.

To read the rest of the series click here