6 Financial Best Practices for New Consultants
This general information is not legal, financial, or tax advice and is being provided for educational purposes only. You should talk to a licensed accountant, lawyer, or financial advisor to see what’s right for you.
When you thought about starting your consulting business, there were probably many things you considered. Finding your first few clients, choosing a specialty, and marketing your business were probably all top-of-mind.
For many new consultants, managing their finances is one of the last things they think about. But setting up a strong financial foundation is too important for you to overlook.
And fortunately, managing your finances doesn’t have to be confusing or stressful. If you’re not sure where to start, here are six financial best practices for consultants to focus on.
1. Choose a business entity
The first place to start is by choosing your business entity. And you have a few different options for how you can get started.
Many new consultants choose to operate as sole proprietors because it’s the easiest way to start a business. A sole proprietor is an unincorporated business that’s run by one individual. You are responsible for any revenue and liabilities the business generates.
If you choose to operate as a sole proprietor, there is no action needed on your part. You have complete control over the business, and since your business isn’t taxed separately, you’ll have it pretty easy come tax season.
But when you operate as a sole proprietor, there is no legal separation between you and your business. So you’ll be held personally liable for any debts the business takes on or lawsuits incurred.
That’s why it may be a good idea to set up a Limited Liability Company (LLC). You’ll gain more credibility as an LLC, and you’ll have liability protection.
To set up your business as an LLC, you will have to file with the Secretary of State and pay an annual fee. And depending on where you live, you may have to pay State Business Taxes and Unemployment Taxes.
2. Apply for your EIN
Even if you don’t have any employees, you’ll need to apply for an Employer Identification Number (EIN). An EIN is a nine-digit number issued by the IRS, and it’s necessary for tax reporting purposes. You’ll probably need an EIN before you can open a business bank account.
To apply, you’ll fill out the online application on the IRS’s website. After the IRS has validated your identity, you’ll be issued an EIN confirmation notice. Be sure to download and save this notice somewhere safe.
3. Open a business bank account
Opening a business bank account will help you separate your personal income from your business revenue. And if you ever need to apply for financing, having a business bank account will make this possible.
It’s a good idea to open both a business checking account and a business savings account. You’ll use the checking account for day-to-day operations and the savings account for taxes and future business investments.
You’ll need the following information to open your account:
- EIN: Having an EIN proves your business’s identity. If you’re a sole proprietor, some banks will let you use your Social Security Number instead.
- Business license: If you received any state licenses, you’ll need this paperwork on hand to show the bank.
- Articles of incorporation: If you filed as an LLC, then you received a document called the articles of incorporation. This document states your business’s name, address, and management structure.
- Personal identification: And finally, you’ll need to verify your identity to the bank. Most banks require either a state driver’s license or passport.
4. Set up bookkeeping software
Once you start working with clients, you’ll need a way to send invoices, accept payments, and track your revenue and expenses. The right bookkeeping software can help you do all of that.
Look for software that comes with time tracking, invoicing, and customer billing features. You also want financial statements so you can keep track of your business’s profitability. QuickBooks, Xero, and Freshbooks are all good options for consultants.
Here are a few things you should look for when you track your business finances every week:
- Are there any invoice payments due in the next week?
- Do you need to adjust your budget to account for late payments or upcoming expenses?
- How much is your business on track to earn for the month?
5. Set aside money for savings
Many consultants find that their income fluctuates from month to month. And there is a certain level of uncertainty that comes with self-employment. Big projects can unexpectedly fall through, and clients will occasionally pay late.
Financial uncertainty is one of the scariest parts of being self-employed. And it’s hard to make smart business decisions if you’re worried about how you’ll pay your bills next month.
That’s why it’s essential to focus on saving up at least three to six months’ worth of expenses in an emergency fund. If you have an emergency fund set aside, it will pull you through during those months when you’re low on cash flow.
6. Set aside money for taxes
Nobody likes paying their taxes, and this can be incredibly stressful for anyone who’s self-employed. As a consultant, you’re responsible for setting aside money for taxes for your quarterly and annual taxes.
And unlike a full-time employee, businesses have to pay estimated quarterly taxes to the IRS. Don’t neglect to save for taxes or you’ll be in for a very unpleasant surprise come tax season.
The amount of money you need to set aside for taxes will vary depending on where you live, but it’s a good idea to save at least 30%. If you end up saving too much, you can put that money toward next quarter’s tax payment.
If you use bookkeeping software like QuickBooks, it estimates how much you owe in quarterly taxes. But it’s still a good idea to hire a CPA, so you know you’re receiving accurate guidance.
Final Thoughts
Running your own consulting business can be very financially rewarding. By focusing on tracking your income and expenses, saving, and staying on top of your taxes, you’ll be able to enjoy all the benefits that self-employment has to offer.
