So You Want to Start Your Own Firm Part 3: Finance & Accounting

Your old firm had an accounting department. You did the engineering work, and the accountants supported you. They made sure adequate money was in the company coffers to pay you twice a month, sent and collected invoices, paid the bills, dealt with the bank (larger firms need lines of credit that allow them to cover differences between incoming and outgoing cash flows), kept the lights and heat on, and interacted with the state and federal taxing authorities.

Unless you or your family has run a small business before, you will need to get up to speed on everything that goes on in the accounting department. Are you capable of handling the financial issues yourself or do you need to hire a bookkeeper or use an online financial platform? Since money likely will be tight when you first start out, you will probably be doing this yourself. But even if you get help, you will need to understand what is being done on your behalf.

You are used to receiving a steady paycheck, but that is probably because your old firm had a line of credit with a bank to pay you during slow periods or when Accounts Receivable (AR) lagged. The conservative approach for you is to only pay yourself as you collect the money. This means planning ahead. Paying yourself as you collect your earnings is likely to mean the money flow will be uneven and “lumpy.”

You pay estimated personal taxes on a quarterly basis. However, the IRS wants Social Security and Medicare taxes to be paid at least monthly. You will need to create an Electronic Federal Tax Payment System (EFTPS) account with the U.S. Department of the Treasury so you can transfer money directly from your company account. At the end of each quarter, you will file a Form 941-- Employer’s QUARTERLY Federal Tax Return with the IRS, which summarizes the wages and taxes paid during the quarter.

In addition to being perhaps the sole structural engineer of your company, you are also the CEO. You will need to attend to plenty of non-project specific business activities. The IRS expects you to pay yourself for that work as an officer of the company in a separate role and to pay Social Security and Medicare taxes on that amount too. One person equals two-employees.

This is easy to do, and you will invite stress if you don’t. You will see why later on. Deposit all the revenue you receive (either by check or direct deposit) into the company account and then pay yourself (net of tax withholdings) by transferring money into your personal account.

You may not have done this before since tax withholdings were taken care of by accounting, but you need to pay your estimated annual tax bill on a quarterly basis by filings with the IRS and your state tax board. This money comes from your company account.

You will need to prepare and file the W2 and W3 (similar to a W2 but for the SSA) forms with the SSA and provide a W2 to your employees (meaning yourself). Keeping an accurate record of what you paid yourself during the year and what you filed with the SSA is critical because it all needs to sum up correctly. The SSA and IRS computers are good with math.

Some of us are better at tracking their time than others. When you work on many projects in a day and are being pulled this way and that, the last thing you want to do at the end of the day is to sit down and fill out your timesheet. I plead guilty, your honor. But I advise you break that habit. I suspect many of your projects will be done on an hourly basis and many clients will want to know what you did for them each day.

You will also need to develop a system for tracking expenses that are company-related, further sub-divided into those that are billable to a job (and therefore find their way onto an invoice) and those that are not. The non-billable expenses are costs to the business and therefore tax deductions on the company tax return. Yes, your company has a tax return, too, and the net income flows to your personal tax return for S Corp filers.

Your old firm had a record retention policy that stated what to keep and for how long and what can be thrown away. Drawings, calculations, specs and correspondence (paper letters and emails). You will need one too. Insurance company folk joke that left to their own devices, engineers would never throw anything away. If they think that is funny, take the hint!

But more importantly, you need to protect yourself against cyberattacks, computer file corruption, and computer hard drive failures. Your old firm may have had an IT department or at least an IT consultant. You probably won’t. You can do all of your work on a cloud-based platform, but you probably won’t. Set up an automatic file back-up system so you don’t need to think about it.

Equally important to doing the work is billing for the work you have done and getting paid for it promptly. “Cash is king “ as the old saying goes, so moving money from your client’s account to your account is a critical function and obviously important to your firm’s health and success.

At the start, you may not have an accounting software package to log your hours on a timesheet that can be used to create invoices. As a sole proprietor, I have found that I can use a simple spreadsheet that I add to each day, and then sort by job number, date, tasks and hours spent and expenses billable to the client and copy all of it to an invoice template. This works well enough for a firm of one or two people, when you might be working on five to ten projects at a time. If you are new to accounting, this also allows you to see how the accounting and billing process works in practice, before you automate billing. Eventually you will want to consider getting an appropriate accounting software package since it will save you time better spent on marketing and doing work. But in the beginning, even simple packages offer more “horsepower” than you will probably need.

Your invoices should note the name of the project as the client refers to it (not as you refer to it), the client’s billing codes, and a clear description of the work you performed. The client can reject an invoice that isn’t formatted as they wish. Even though this may sound obvious, add at the bottom that the invoice is “payable upon receipt” and that your invoice states the expected payment time consistent with your proposal terms. If you take invoicing and payment activities seriously, hopefully your clients will understand your professionalism and do the same. Don’t be bashful or reluctant to discuss payment or ask about the status of payment. You worked hard for your money, and the client owes prompt payment to you. You are not their bank.

You will need to keep track of invoices sent and the date sent so you can track accounts receivable, or AR. If you are getting paid within 30 days, things are going well.

If an invoice is still outstanding after 45 days, make a call to inquire when you can expect payment. Be respectful but firm. Remember “cash is king” and you cannot spend or pay yourself with money you don’t have. This is particularly important when just starting out on your own because you may have a large fraction of your billings with only one or two clients. If the invoice isn’t paid after 60 days, something is likely wrong.

To minimize the amount of AR aging, you can do two things. First, understand when your client processes invoices and make sure your invoice arrives a few days before. It doesn’t hurt to give them a friendly call to confirm receipt. This is also an opportunity to say hello and inquire about new work since marketing opportunities should never be overlooked. Missing the client’s invoicing processing date by even one day could add 30 days to the time until you receive payment. Second, work directly for the entity with the money if you can. Working for an intermediary, such as an architect or contractor, will likely only add to the time for payment since there are more chances for missed steps by others along the way. Intermediaries will also usually only “pay when paid,” so if they are not good about getting paid promptly themselves—or your invoice is caught up in a group of invoices that are not being paid promptly for reasons that don’t involve you—these delays will trickle down to you too.

Extended AR aging, 60 to 90 days or more for a small firm, may be acceptable for larger firms, but should serve as a sign of trouble for a smaller firm and indicate the possibility of you not getting paid, i.e. turning into bad debt. This may occur for many reasons, such as the client is having financial troubles, the intermediary is having financial troubles, or there is a dispute about the validity of the invoice and the scope of services.

In Closing

I hope that you found helpful my summary of what I learned and what you can expect and need to understand when considering starting or starting your own firm. I have tremendous respect for every small business owner. They took the leap into the unknown for reasons they may not be able to articulate and ended up with more work and two distinctly different jobs when they had only one safe one before. They may have known little about running a company, or they were smart and discussed the challenges and opportunities with a trusted friend or mentor. Yet whatever they did, and regardless of the number of questions they asked or advice they were given, unknowns will always come up. Starting a business will be a bit scary, since you are putting yourself out front, exposed so to speak, with no one to hide behind. I am quite sure this is an uncomfortable place for many engineers, but you will find it can be an exciting and rewarding opportunity too. Didn’t you always want to be the boss? ■

This article is intended for informational and educational purposes only and should not be considered financial, accounting, tax, or legal advice. Every business has unique circumstances, and laws and regulations may vary by location and change over time. Before making financial or tax-related decisions, consult a qualified accountant, tax professional, or attorney who can provide advice tailored to your specific situation.

About the Author

John A. Dal Pino, SE, is a Principal with Claremont Engineers Inc., Oakland, California and the Chair of the STRUCTURE Editorial Board.