Welcome to the 4th lesson in the Consulting Crash Course.
In this section we're going to cover:
Accounting & Bookkeeping
Accounting & bookkeeping are related but not identical terms.
Accounting is the process of summarizing, analyzing, and communicating financial transactions to gauge the financial health of the company and report to relevant authorities (IRS, state).
Bookkeeping is the process of recording financial transactions, usually by entering them into accounting software or a physical set of “books.”
You want to be able to handle the basic day-to-day bookkeeping tasks so your accountant can prepare your financial statements (balance sheet, income statement, cash flow statement) and file your tax documents.
Accounting comes down to tracking debits and credits.
Debits are transactions that increase an asset or decrease a liability.
Credits are transactions that increase a liability or decrease an asset.
Assets are things that you own (equipment, property, cars, cash).
Liabilities are things that you owe (loans, supplier invoices, employee salaries).
The amount of debits always equals the amount of credits. They are equal but opposite transactions. For example, if you buy a laptop, the asset gained is tracked as a debit. The expense/payment is tracked as a credit.
Equity is your assets minus your liabilities and represents how much is left over after you’ve paid off your creditors. This is the net worth of your business.
Equity = Assets - Liabilities or Assets = Liabilities + Equity
Accounting is responsible for correctly tracking all your transactions and using them to make business decisions, generate financial statements, and determine tax obligations.
Here are some resources where you can learn more on accounting:
Account - “In the world of bookkeeping, an account doesn’t refer to an individual bank account. Instead, an account is a record of all financial transactions of a certain type, like sales or payroll.”
There are five basic types of accounts:
Bookkeeping starts with setting up the necessary accounts. You won’t have the same exact accounts as other businesses, but many accounts are common.
Here are some common accounts:
Once your accounts are set up, you want to track every business transaction and log them to the correct account. Recorded transactions in your accounting system are known as journal entries.
It’s important that each debit and credit transaction are recorded properly in the correct accounts. Otherwise your accounts won’t match and you won’t be able to close your books.
You buy some software for $1000 in cash.
This transaction affects 2 accounts, cash and equipment. You record a $1000 debit for the equipment account (increased asset) and a $1000 credit for the cash account (decreased asset).
After all transactions have been recorded for a set period of time (monthly or quarterly), it’s time to balance and close the books.
Your total debits should match your credits. This means the books are “balanced”. If the totals do not match, you’ll have to go through your journal entries to find errors and correct them.
At the end of the year, your books should be balanced and ready to prepare financial and tax documents.
Here are some resources where you can learn more on bookkeeping:
QuickBooks Online - QBO
If this feels overwhelming, don't worry!
Accounting software, like QuickBooks Online (QBO), helps automate many of these tasks. QBO creates a basic/default chart of accounts and helps organize your bookkeeping. Their interface allows you to enter transactions and handles the debits and credits behind the scenes.
It allows you to track your customers, time, invoices, expenses and more. Once you set up your QuickBooks account you want to connect it to your bank account. From there you can match your payments from your bank account to your invoices in QuickBooks.
I'm not going to go in detail on how exactly to use QuickBooks to do your accounting. If you need help with QuickBooks there are tons of tutorials online and very helpful QBO groups through Facebook groups. If you have a specific question that you can't find online, most people are happy to help. Here's a link to a basic tutorial if you're new to QuickBooks.
Finding an Accountant
It's highly recommend that you find someone that you can ask for accounting and bookkeeping advice.
Referrals are one of the best ways to find a trusted accountant. Ask your friends, family, and colleges if they can recommend anyone. You can also get referrals by attending small business events and asking there.
If you can’t get a referral, you can find a local CPA (certified public accountant) using the American Institute of Certified Public Accountants (AICPA). The AICPA has a directory of CPAs, accounting companies, and local accounting organizations.
You can use Google but use it mostly for research and reviews to help you find someone. There are so many options on the internet it can be hard to know what is the right choice.
You’ll want to do your research and evaluate your accountant before you start working with them.
Good questions to ask are:
More info on finding an accountant - Fundera
Taxes & Benefits
You should set aside about 30 to 35% of your revenue to pay your taxes. This mainly covers your income tax and self-employment tax. More info on that here.
You're supposed to pay your taxes quarterly throughout the year so you don't have a lump sum of taxes to pay at the end of the year. However the fee is minimal if you don't do that. It's only like a $100 or $200.
Healthcare is the only benefit that may be legally required in your state. Research your state laws to see if it’s required for you.
Health insurance plans vary widely based on your location, health condition, and dependents. Assume plans without financial assistance will be a few hundred dollars a month. Here's a link that shows the average healthcare cost in the US.
Life insurance, dental insurance, vision insurance, and retirement benefits are common employee benefits you will not receive. If you want any of these services, you must research and set them up yourself.
Process of Getting Paid
Let's talk about the process of how to get paid.
First off, while you're working you need to keep track of work you're doing. Once you're ready to bill the client you should put together an invoice. The client should receive the invoice and be able to pay you electronically through QuickBooks or via check. Checks should be made out to your business name. Once you receive payment in your business bank account, pay yourself roughly 65-70%. That means, you can transfer that money into your personal account and use it for anything you need. The remaining 30-35% is aside for taxes and other business expenses. Then match the payment to the invoice in QuickBooks.
Since you need to keep track of your work I highly recommend using some sort of software to keep track of how much you're working and what you're doing. We conveniently have an app that tracks time, creates invoices and syncs them to QuickBooks so if you need something for that check out HoursLogger.
Invoices should be simple and straightforward.
They should include:
Most states don’t require you to pay sales tax on your consulting services.
Search “consulting services sales tax [your state]” to see if you’re required to include sales tax on your invoices.
Here is an example of a PDF invoice.
Since you have to pay all your own taxes you want to try to minimize the amount that you're paying. The main way to do that is using business expenses.
Business expenses can be deducted to reduce your taxable income. A very simple example is if you buy a $1,000 QuickBooks subscription for your business and you made $100,000 for the year, You can deduct that $1,000 from your taxable income so it's now $99,000. You save money on the taxes you owe because you only have to pay tax on $99,000, not $100,000.
There are rules that govern what a valid business expense is and how much it affects your taxable income. One of the best places to read up on this is the IRS. Here are a couple links that cover what are business expenses and what are the common ones for your business.
That's all for this lesson. In Contracts for Consultants we'll cover the various contracts used by consultants.
If you found this useful, please share it and try HoursLogger if you need time tracking and invoicing for your business.