Which of These 4 Business Structures Is Best for Your New Business Idea?

One of the first things to consider when starting a business is to determine the legal structure for your business. Your business structure will influence day-to-day operations, liability obligations, and how your business is taxed. Therefore, you should choose a business structure that provides you with both legal protections and benefits.

There are four common business structures: sole proprietorship, partnership, corporation, and limited liability company. In today’s article, we’ll discuss the basics of each business structure along with its advantages and disadvantages so you can choose one that fits your circumstances.

1. Sole proprietorship

A sole proprietorship is the simplest business structure, with one person in charge of the company’s day-to-day operations. For entrepreneurs who wish to test their business idea before creating a more formal company, sole proprietorships are a good option.

Sole proprietorships don’t have their own legal entity, which means your business assets and obligations are undetached from your personal ones. For example, the profits of the sole proprietorship flow directly to its owner. And as you’re the only one who established the business, it’s obvious that the income will go into your pocket. 

The same rule will apply to your liability obligations which means you’re personally responsible for your company’s liabilities. This, on some occasions, could place your assets at risk, as they could be seized to satisfy a business debt.

There are several advantages when you structure your business as a sole proprietorship. Sole proprietorships are inexpensive to set up, and when running the business there are minimal fees (such as business taxes and operating license fees). Also, you may be eligible for tax deductions, such as health insurance. Another plus is that this type of business doesn’t require activities such as shareholder meetings, nor do you need to hold voting or election of directors.

On the downside, it’s often difficult to raise capital for sole proprietorships. This is because as a sole proprietor, you have no stock to sell, not to mention that banks and credit unions are hesitant to lend to sole proprietorships. As a result, you may heavily depend on your financing sources, such as savings, home equity, or family loans.

When it comes to filing taxes, the process is easy to follow. Because a sole proprietorship doesn’t exist as a separate legal entity from its owner, you’re not required to file separate income tax forms. In the US, all you have to do is fill in the personal income tax return, Form 1040, and attach it along with Schedule C, a report of profit or loss from a business. 

2. Partnership

A partnership is a form of a business structure owned and operated by several individuals. This is the simplest business structure with two or more owners. Partnerships are considered a suitable option for businesses with multiple owners or professional organizations (such as attorneys) looking to test their business idea before establishing a more formal company.

Partnerships come in two varieties: limited partnerships and limited liability partnerships. In limited partnerships, there’s only one general partner with unlimited liability and several other partners with limited liability. As a result, the general partner operates the business and assumes liability for the partnership, while the limited-liability partners have little control over the business and aren’t subject to the same liabilities as the general partner. This will be stated in a partnership agreement.

Limited liability partnerships are similar to limited partnerships, except that all partners who join to form the business have limited liability. Each partner in a limited liability partnership is protected from obligations owed to the partnership, and they aren’t liable for the activities of other partners.

The biggest advantage when forming your business as a partnership is the tax treatment your business enjoys. A partnership doesn’t pay tax on its income but passes through any profits or losses to the individual partner’s tax returns. When tax season in the US comes around, the partnership files a tax return Form 1065 that submits it to the IRS. Along with that, each partner fills in Schedule K-1 of Form 1065 to report their share of income and loss.

However, partnerships also have disadvantages, such as complicated paperwork when registering the company. Besides, if any disagreements occur between the partners, it would slow down the business’s operations. 

3. Corporation

Corporations are more complex than the other two business structures above. A corporation is an independent legal entity, separate from its owners. Therefore it often comes with more regulations and tax requirements.

In the US, there are two main types of corporations: C-corporations and S-corporations. A C-corporation is a legal entity independent from its owners, while an S-corporation can have up to 100 shareholders and operates somewhat similarly to a partnership.

The most significant advantage for a corporation is its liability protection to each shareholder. Because a corporation’s debt isn’t considered its owners’ debt, forming your company as a corporation won’t put your personal assets in danger. Another plus is the ability to raise capital. A corporation can sell stock to raise funds. 

One drawback of corporations is that they are subject to more requirements, such as meeting, voting, and the election of directors. Also, it’s more expensive to set up a corporation than a sole proprietorship or partnership.

When it comes to taxes, a corporation is subjected to pay both federal and state taxes. At the same time, earnings distributed to each shareholder in the form of dividends are taxed on their personal income tax returns. In other words, owners of a corporation may pay a double tax on their business’s earnings.

4. Limited liability company

A limited liability company is a hybrid business structure that brings together the characteristics of both partnerships and corporations. Limited liability companies have been around since the 70s, but they have only gained popularity recently. 

Unlike an S-corporation, which has a limit of 100 shareholders, a limited liability company has no such restriction. When registering a limited liability company, you must submit the articles of association with the Secretary of State in the state in which the company intends to do business. In some states, an operating agreement is an additional requirement.  

On the positive side, a limited liability company comes with fewer paperwork requirements when setting up the business than a corporation. The limited liability company provides personal liability protection to business owners, which means personal assets won’t be at risk if your company faces bankruptcy or lawsuits. 

On the downside, a limited liability company costs a fair amount to set up. Also, it may need to hire a technical accountant and an attorney to ensure that it complies with tax and regulatory requirements.

When filing taxes, the profits and losses of the business are passed on to the owners without facing corporate taxes. However, a limited liability company member is considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security.

The bottom line

This article covers the basics of four business structures as well as their advantages and disadvantages. It gives you a good grasp to choose which business structure you’ll go for when you start your “venture” journey.

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Is Double-Entry Accounting Right for Your Business? Your Complete Guide!

If you’re a freelancer, sole entrepreneur, or independent contractor, you have to decide your business’s accounting system: double-entry or single-entry? You might have been using single-entry accounting, especially if you aren’t using accounting software. While this may have been sufficient initially, you should probably move to use accounting software and double-entry accounting if you plan to grow your business. 

In this article, we’ll walk you through double-entry accounting as simply as possible. We’ll explain how it differs from single-entry, and help you decide which accounting system suits your business best.

What is double-entry accounting?

Double-entry accounting is a bookkeeping method that maintains the balance of a company’s accounts. This method shows the most accurate picture of the company’s finances. At its core, this method relies on the accounting equation Assets = Liabilities + Equity. 

This accounting system was invented by Benedetto Cotrugli, an Italian merchant, in 1458. This system was later shared by the Italian mathematician and Franciscan friar Luca Pacioli, the author of The Collected Knowledge of Arithmetic, Geometry, Proportion, and Proportionality, which included a detailed description of the double-entry accounting system.

Using double-entry accounting is the only way to make sure all of your transactions follow the accounting equation rules. Unlike single-entry accounting which only requires that you post a transaction into a ledger, double-entry tracks both sides (debit and credit) of each transaction you enter. Using the double-entry accounting system reduces errors and makes it easier to produce accurate financial statements. Later in the article, we will take a look at a real-world example to help make these concepts even more clear.

See more: A Small Business Guide To General Ledgers.

Types of accounts

When you employ double-entry accounting, you will need to use several types of accounts. Some key account types include:

  • Assets: Assets are resources owned by a company, which represent future economic value. Some examples of asset accounts are accounts receivable, cash, and equipment. 
  • Liabilities: Liabilities are amounts owed or committed by a company, such as accounts payable, loans, and accrued expenses. 
  • Equity: Equity is the amount of funds invested in a business by its owners plus all retained income from operations. Common examples of equity are paid-in equity (funds from investors), retained earnings, and common stock. 
  • Revenue: Revenue is the money generated from any operating activities, like product sales, service fees, and interest income. 
  • Expenses: Expenses are all costs incurred in running a business, such as inventory purchases, employee wages, and depreciation. 

What are debits and credits?

Debits and credits are fundamental to the double-entry system. In accounting, a debit entry appears on the left side of an account ledger, while a credit entry appears on the right side. A transaction’s total debits and credits must be equal to be in balance. Credits don’t necessarily imply increasing, and debits don’t always imply decreasing. 

A debit may increase one account while decreasing another. For example, a debit increases asset accounts but decreases liability and equity accounts, supporting the general accounting equation of Assets = Liabilities + Equity. 

Debits increase the balances in expense and loss accounts on the income statement, while credits decrease their balances. Debits decrease revenue and gain account balances, while credits increase their balances.

To make things a bit easier, we’ve made this table to show you how debits and credits work under the double-entry bookkeeping system:

DebitsCredits
– Are always recorded on the left side
– Increase an asset account, or decrease a liability account or equity account (such as owner’s equity).
– Increase an expense account.
– Decrease revenue
– Are always recorded on the right side
– Increase a liability or equity account, or decrease an asset account.
– Decrease an expense account.
– Increase revenue

How double-entry accounting works

Setting up and operating a double-entry accounting system includes four key steps. It starts with setting up the accounts in which bookkeepers will record transactions and ends with using account information to generate financial statements. The steps are: 

  • Stage 1: Create a chart of accounts for posting your financial transactions. This chart is a complete listing of all the general ledger accounts that a company can use to record transactions. It contains all the accounts for each of the five types: assets, liabilities, equity, revenue, and expense. Nowadays, most accounting software comes with pre-made charts of accounts available for customization, while other accounting solutions offer customized charts of accounts.
  • Stage 2: Enter all transactions with equal amounts of debits and credits to reflect the elements of a transaction. Debits and credits can be recorded in any monetary unit, but the currency should be consistent throughout the accounting process.
  • Stage 3: Ensure each entry has two components; debit and credit. And, ensure that they are in balance with the accounting equation. Using accounting software can help you with this. 
  • Stage 4: Check and ensure that financial statements balance and reflect the accounting equation. The net account totals in the double-entry accounting system are fundamental to creating the company’s working and final balance when closing the books at the end of each accounting period. The final adjusted balances flow into financial statement line items. Nowadays, accounting software can automate the integration and process flow necessary to do this.

An example of double-entry accounting

Let’s explore a realistic example of double-entry accounting for a common business transaction. If you buy a new $1000 laptop for your freelance startup and you would like to record the expense, here’s how you’d do it: 

First, you need to enter a $1,000 debit to increase your asset statement “Laptop” expense account and a $1,000 credit to decrease your balance sheet “Cash” account. 

DATEACCOUNTDEBITCREDIT
12/29/21Office equipment$1,000
12/29/21Cash Account$1,000

In double-entry accounting, you still record the $1,000 in your cash account, but you also record that $1,000 as an expense.

Should I use double-entry or single-entry accounting? 

Single-entry might be enough for your accounting needs if your business is very simple, has only one employee, doesn’t have any inventory or debts, and doesn’t have many accounts to keep track of. 

Otherwise, if your business is any more complex than that, most accountants will strongly recommend switching to double-entry accounting.

Why? Though single-entry accounting is simpler to implement, it has significant drawbacks compared with double-entry accounting. Single-entry accounting is more prone to errors, especially omissions and duplications, because it lacks the control method of balancing accounts.

Furthermore, single-entry accounting can’t create a complete financial picture of the business. It only records cash inflows and outflows, indicating when cash is in hand versus when it is actually earned. It also doesn’t indicate items like sales made on credit. Moreover, single-entry accounting requires extra work in the closing process to yield balanced financial statements. Lastly, single-entry accounting is unsuitable for public companies because it’s not accepted under GAAP (Generally Accepted Accounting Principles.)

Double-entry accounting provides you with a more complete, three-dimensional view of your finances than the single-entry method ever could. Since you’re recording where your money is coming from and where it’s going, you can then collate that information into financial statements. This gives you comprehensive insights into the profitability and health of various parts of your business. That’s a win because accurate financial statements can help you make better decisions about spending money in the future.

Double-entry accounting also reduces the risk of bookkeeping errors, improves financial transparency, and provides a layer of accountability to your business that single-entry accounting cannot.

If you want your business to be taken seriously by investors, banks, and potential buyers, you should be using double-entry.

The bottom line

Accounting entries are the foundation of every company’s accounting system. Taking good care of those documents means better control over your expenses. 

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Balance Sheet Explained – A Basic Guide

A balance sheet is one of the three most important financial statements. It provides a crucial insight into how your business is doing financially at a given point in time. This article will take a deep dive into the ins and outs of balance sheets.

Related articles:

Balance sheet explained 

Simply put, a balance sheet displays a business’s assets, liabilities, and owner’s equity at any given point in time. A balance sheet provides an overview of what your business owns, what it owes, and the amount invested by its owners. In other words, it summarizes your business’s worth, so you can better understand its financial position. A balance sheet is also known as a statement of financial position. 

Key components of a balance sheet 

A balance sheet has three main parts: assets, liabilities, and shareholder’s equity. In each part, relevant items are listed and they must match the accounts outlined on your chart of accounts. 

Let’s take a closer look at the three components of a balance sheet:

  1. Assets 

The assets section lists everything your business owns that provides economic benefits. The sub-items are arranged in order of liquidity, or how easily they can be converted to cash. 

The assets section is divided into the two following categories: 

Current Assets: Assets that can be turned into cash within one year. Here are some current assets that companies commonly own:

  • Money in a checking and/or savings account
  • Cash equivalents (currency, stocks, and bonds)
  • Accounts receivable (money customers owe when buying products/services on credit)
  • Short-term investments
  • Prepaid expenses
  • Inventory

Non-Current Assets (Long-Term Assets): assets that will take more than one year to be converted to cash. Some examples of non-current assets are:

  • Land and property 
  • Machinery and equipment 
  • Intellectual assets (copyrights, patents, trademarks, etc.)
  • Goodwill (value from brand name, customer base, reputation, etc.)
  • Long-term investments 
  1. Liabilities 

Following the assets section are liabilities. Your liabilities are everything that you owe to others. Similar to assets, liabilities are also broken down into current and long-term liabilities.

Current liabilities are debts due within a year. Items are listed in order of their due date. Here are some examples:

  • Rent 
  • Utilities
  • Taxes
  • Short-term loans
  • Accounts payable (money owed when buying goods on credit) 
  • Interest payments

Long-term liabilities have due dates longer than one year. For example:

  • Long-term loans
  • Deferred income taxes
  • Pension fund liabilities.
  1. Equity 

Equity is the last section in a balance sheet. It refers to the money owned by the business owners or shareholders. In other words, equity is your net assets. The most common items belonging to this section are:

  • Capital (money put into the business by the owners)
  • Private or public stock
  • Retained earnings (net earnings to reinvest or pay off debts)

The balance sheet golden rule 

A balance sheet must follow a golden rule or an accounting formula as follows:

Assets = Liabilities + Equity

What your business owns always has to be balanced with what it owes plus its equity. This is because your assets either come from your borrowings or your own money. 

What does a balance sheet look like?

Normally, a balance sheet will be divided into two columns: assets on one side and liabilities plus equity on the other. However, it’s not unusual to see a balance sheet looking like a long, endless list. You decide the format most suitable to your business! 

Source: FundNet 
Source: Accounting Guide 

Why is a balance sheet important? 

A balance sheet is an important financial document as it allows you to look at your business’s position in detail. When comparing the current balance sheet to ones in the past, you can analyze and understand your business operations better. Think of it as a regular health check for your company. The balance sheet allows you to make better decisions by giving you an insight into what your business is doing well and what it’s not.

Here are a few financial areas that can be improved by leveraging a balance sheet:

Liquidity 

It’s always challenging for any business to calculate how much cash they have readily available. With the figures on a balance sheet, businesses can work out and analyze critical financial metrics like the current ratio (current assets ÷ current liabilities) or quick ratio ((current assets – inventory) ÷ current liabilities). Interpreting these ratios correctly will help you find the best ways to manage your company’s liquidity.    

Efficiency 

You can determine how efficiently your company uses its assets by comparing your balance sheet with other financial statements. Through calculations and analysis, you’ll be able to determine which areas in the business are generating profits. Then, you can make better plans for future investments or capital allocation.  

Risks

Your balance sheet summarizes how much debt you owe, which can tell you how much financial risk you face. Being aware of your debt situation allows you to make wiser business decisions and avoid potentially damaging events that could lead to bankruptcy. 

Who prepares the balance sheet?

Depending on your business’ size and model, the balance sheet may be prepared by different people. For example, in a small privately-owned business, a bookkeeper will prepare the balance sheet. For a mid-size private firm, their accountants may prepare it first, then have it reviewed by an external accountant. 

Key takeaways 

The balance sheet is an important financial document that you can’t overlook. Understanding what it is, how it works, and how it correlates to the rest of your business are a great advantage for any business owner. 

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