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5. FINANCIAL MATTERS

b. Books and Records

Overview

Your company should maintain financial books and records that are complete and accurate. To accomplish this goal, consider hiring a bookkeeper or using financial software such as QuickBooks. You should also consult with a certified public accountant (CPA) during the formation phase, and the CPA can help set up the books and records.

Establish the “fiscal” year for your company. Most companies use the calendar year as the fiscal year. Also determine the accounting method for your company. The most common methods are “cash basis” and “accrual basis”. Note that tax laws may limit your options on these matters.

You should consider purchasing a company binder from a vendor at an approximate cost of $80. The binder would hold your company records, company seal (optional), ownership certificates (optional), owner registers, meeting minutes and related documents, and perhaps other items.

Financial Statements

Arrange for someone to prepare financial statements on an annual basis and perhaps more often (quarterly or monthly). “Financial statements” usually include a balance sheet, income statement, and cash flow statement. The balance sheet is a snapshot of assets, liabilities, and owners' equity at the end of the year. The income statement shows profits and losses for the entire year. The cash flow statement shows the cash flowing in and out of the company throughout the year.

Mandatory Records

Certain records are required by law. For example, federal tax law requires companies to keep their tax returns and receipts for specified periods. The state law of California requires LLC's to maintain the following records at an office within the state:

• current list of the name, address, capital contribution, and profit/loss share of each member, "economic interest holder", and manager
• copies of the articles, operating agreement, amendments, and any “powers of attorney” used to execute the documents
• copies of the LLC's federal, state, and local income tax or information returns and reports for the six most recent taxable years
• copies of the LLC's financial statements for the past six fiscal years
• books and records related to internal affairs for past five fiscal years

Delaware imposes similar but less extensive requirements on Delaware LLC's. However, if California residents own at least 25% of the voting interests of a Delaware LLC, then California law requires the company to comply with the above requirements applicable to California LLC's.

Capital Accounts

“S corporations” and LLC's taxed as partnerships must maintain “capital accounts” for their owners. Capital accounts are not bank accounts, but merely records of the ownership interests of the owners. Each owner has a “capital interest” representing a proportional share of the net assets or liabilities of their companies.

Your company must allocate every item of income, gain, credit, loss, or deduction among the capital accounts. Usually, such allocations correspond to the ownership percentages. However, federal tax law may allow LLC's (but not “S corporations”) to make “special allocations” not in accordance with ownership percentages, if the company has legitimate business reasons.

Capital accounts are usually prepared by CPA's at the end of each fiscal year.

Expenses

Once you successfully file the articles for your company, contact the IRS for a taxpayer ID number (TID). The TID is also known as an “employer” ID number or “EID”. You may obtain the TID immediately by telephone or Internet. For more information, see the IRS website.

Once you have the TID, you should open new bank accounts in the name of your company. At a minimum, get a checking account with company checks and debit cards. If your company has employees, also open a payroll account. Additional options are a savings account, money market account, and credit cards. Professional companies may need client trust accounts.

Going forward, pay all company expenses with company checks, credit cards, and debit cards. If you pay expenses from your personal accounts, you create tax, accounting, and legal problems. From a tax perspective, your company may lose the ability to deduct the expenses from its taxable income. From an accounting perspective, the expense might avoid detection when your bookkeeper creates financial statements for your company. From a legal perspective, you create the risk of personal liability under an “alter ego” theory.

Client Payments

The success of your company will depend on its ability to collect payments from clients or customers. As soon as possible, implement your payment procedures by creating invoice templates and related documentation. The commercial standard is “net 30 days”, which means that payments are due within 30 days of the invoice dates. An alternative due date is the last day of the month when you issue the applicable invoice.

Establish policies regarding late payments and include the policies in your written sales agreements and invoices. The policies should indicate your remedies for collecting late payments. State that the remedies are “non-exclusive”. The remedies may include one or more of the following:

• interest of 1.0 - 1.5% per month to compensate your company for lost income*
• one-time “penalty” (liquidated damages) of 5-10% to compensate for initial collections activities*
• suspension of continued performance under the contract, if applicable
• termination of contract
• arbitration or litigation proceedings
• reimbursement of legal fees

*Discuss the interest and penalty remedies with an attorney to verify compliance with applicable laws.

Collections is one of the biggest headaches of entrepreneurs. When you work hard to provide a customer with a valuable product or service, you will expect timely payment in full. Unfortunately, when your company is just getting started, many of the initial clients will test your patience. In order to reduce the risk of payment defaults, (i) provide estimates prior to signing the client agreements; and (ii) demand advances payable upon signing.

By providing estimates, you avoid giving your clients sticker-stock when they receive your invoices. Update the estimates as necessary to reflect changed circumstances.

With regard to the advances, require payment of 10-50% up-front. The percentage depends on such factors as customary practice in your industry and creditworthiness of the client. The unearned portion of the advance may or may not be refundable. Your client agreements should state your policy clearly, especially if you wish to retain the unearned portions.

Delivery of Records

State law may require your company to deliver certain records to the owners and other interested persons. For example, if your company is a California LLC, it must provide its members and “economic interest holders” with the following:

• information for their personal income tax returns within 90 days after the end of each taxable year
• copies of the company income tax returns, if the LLC has 35 or fewer members
• annual reports and maybe quarterly reports, if the LLC has more than 35 members
• copies of amendments to the governing documents, if executed pursuant to “powers of attorney”

In addition, every member, economic interest holder, and manager of a California LLC has the right to inspect and copy the mandatory records of an LLC. The inspection must be “reasonable” -- meaning, among other things, that it must place during normal business hours and for purposes reasonably related to the interest of the person making the request. If your California LLC has more than 35 members, additional inspection rights apply.

Delaware grants similar rights to members of Delaware LLC's. In addition, if your company is a Delaware LLC in which California residents own at least 25% of the voting interests, then your company must comply with the record requirements of California as well as Delaware.