Unit 7

Managing Finances

Topics covered: Financial concepts; financial planning; budgeting; taxes Now that you have that money, what do you do with it? Successful businesses don't just do well at bringing in funds, they also do well at managing it. In this unit we'll cover the basic concepts of accounting, financial management, and taxes. Understanding the importance of these concepts will lead you on the path to financial stability.

Sections
Introduction to Financial Concepts
Managing Finances and Financial Planning
Introduction to taxes

Section 1

Introduction to Financial Concepts

Before we can dive into the nitty-gritty of earning money, we need to have a discussion on the essential terminology and documentation of finance. Once you build the sandbox, you can start... building... castles of money? That's terrible. Moving on.

Parts
Introduction to Financial Terminology
Introduction to Financial Reports

Part 1

Introduction to Financial Terminology

In order to dive into the different aspects of the finance unit, such as sales, fundraising, etc. we need to first understand some basic terminology and concepts:

Assets and Liabilities

• Assets — The economic resources that you have. This can include inventory, cash, supplies, furniture, equipment, trademarks, copyrights, patents…

  Anything that adds to the value of the business or can be sold (liquidated) to make money.

• Liabilities — This is what you owe to others. Liabilities include any debt accrued by the business, any money you owe others, loans, credit card bills, rent, mortgages, etc.

  Two types: Current and long-term.

— Of the following examples, which is an asset? Which is a liability? Both?

What are some examples of assets and liabilities in creative practices?

• For an architecture firm specializing in new material applications?
• For a presenting theatre company with a brick-and-mortar location?
• For an independent studio practice that sells primarily through art fairs?
• For a design firm specializing in product design?
• For a touring musical act that plays arena shows?
• For an independent film production?

Income, Expense, Capital, Debt Financing, Owner's Equity

• Income — Money received for work (sales or services) or capital (raised funds).

• Expenses — A cost incurred in order to operate. There are two main types: fixed and variable.

  • Fixed Expense — Costs that do not change, regardless of changes in sales, production or services. Think of things like rent, union dues, salaries, etc.
  • Variable Expense — Expenses that change unpredictably based on market behavior. Think of things like raw materials, contractor labor, or shipping.

• Capital — The money or wealth needed to produce goods and services. Think of this as the money in your piggy bank. Typically these are funds that were raised, allocated, or that come from some type of investment.

• Debt Financing — Borrowing money without giving up ownership. Think of loans, mortgages, and credit. Debt is a type of Capital

• Owner’s Equity — The value of a company. This can be a tricky concept to understand. Essentially, once you subtract what you owe people (liabilities) from what your resources (assets), what you have left represents some value. That value is the value of the company. It's what the company is worth.

  • OE = Assets - Liabilities
  • Owner’s Equity is a type of Capital

What are some examples of...

• Income?
• An expense?
• Capital?
• Debt financing?
• Owner's Equity?

...for a(n)...

• Architecture firm specializing in new material applications?
• Presenting theatre company with a brick-and-mortar location?
• Independent studio practice that sells primarily through art fairs?
• Design firm specializing in product design?
• Touring musical act that plays arena shows?
• Independent film production?

Profit, Loss, Cash Flow, Valuation, Appreciation, Depreciation

• Profit and Loss — When your income minus expenses equal a positive number, it’s a profit. When it’s negative, it’s a loss.

• Cash Flow — The monthly movement of funds, including both income and expenses.

• Valuation — The monetary worth of something. Literally, its value. Usually assigned through an appraisal process.

• Appreciation and Depreciation — The increase or decrease in the value of an asset over time.

*Let's analyze a few examples: *

Now, can you provide some examples for a(n)...

• Architecture firm specializing in new material applications?
• Presenting theatre company with a brick-and-mortar location?
• Independent studio practice that sells primarily through art fairs?
• Design firm specializing in product design?
• Touring musical act that plays arena shows?
• Independent film production?

Part 2

Introduction to Financial Reports

Financial reports are the uniform documents that help you understand the financial health of your business. Financial reporting consists primarily of a few different types of financial statements:

• Balance Sheet (For nonprofits this is called a Statement of Financial Position)

• Income Statement (For nonprofits this is called a Statement of Financial Activities)

• Cash Flow Statement (For nonprofits this is called a Statement of Financial Activities)

In addition to these three primary financial statements, nonprofits also have the Statement of Functional Expenses

Let's watch a video!

The Balance Sheet

• The balance sheet shows the company’s worth over a specific period of time.
• It is comprised of Assets, Liabilities, and Owner’s Equity
• Ideally: ASSETS = LIABILITIES + EQUITY
• Put another way: What you own (ASSETS) - what you owe (LIABILITIES) = your company’s value and wealth (OWNER’S EQUITY)

The Income Statement

• The income statement shows both the company’s Income and Expenses over a specific period of time.
• The income statement shows if a company is making a Profit or a Loss.
• The formula is simple: Income - Expenses = Profit (+) or Loss (-)

The Cash Flow Statement

• The cash flow statement records any money (cash + cash equivalents) that comes in and out over a specific period of time.
• It shows where money is being spent and where it is being gained.

Statement of Functional Expenses (nonprofit ONLY)

• The Statement of Functional Expenses further breaks out a nonprofit's expenses into three categories:
  • Administration and management — Also called "overhead", these are expenses like salaries, benefits, rent, utilities, etc. that are everyday costs of running the organization and do not have a specific program or purpose.
  • Fundraising — Gotta spend money to make money. Those expenses need to fall here. An example could be the expenses of a fundraising gala.
  • Programs — These are expenses incurred to carry out the mission and purpose of your organization.

Why the extra effort to break out expenses?

• It's a necessary aspect of a nonprofit's annual reporting requirements.

Section 2

Managing Finances and Financial Planning

Whether you're a sole proprietor or a C corp, you have to have your finances in order. Being organized about you money and planning for the future are one of the most solid foundations you can lay for your creative practice.

QUICK DISCLAIMER: I'M NOT AN ACCOUNTANT.

Parts
Managing Finances
Financial Planning

Managing Finances

From a high-level, we're going to discuss the following:

1. Banking
2. Spending
3. Receiving
4. Tracking

1. Banking

• If your creative practice is going to be a significant source of income, separate it from your personal finances and sign up for a business banking account.
• Remember, it’s best to keep personal and business assets separate.
• You can sign up for a business bank account through most banks — even as a Sole Proprietor.

2. Spending

• CASH — Keep track of cash. Separate business cash from personal cash. Deposit cash ASAP.
• CHECKS — Use your business bank account checks, not personal checks. This is especially important if more than one person needs access to the back account.
• CHARGING — Sign up for business-specific credit cards and debit cards. Do not use you personal cards if possible. This is especially important if you have multiple people using the same credit card.

3. Receiving

• GETTING PAID — You need to document the whole payment process:
  • Have a written agreement in place
  • Send an invoice to request payment
  • When you receive the payment, send a receipt
  • Check your bank records to make sure the check/payment clears.
• Always deposit money as soon as possible.

4. Tracking

• RECORDING — Decide if you will use Accrual basis or Cash method for accounting.

  • Accrual Basis — Transaction recorded when the money is earned, but not yet received.
  • Cash Basis — Transaction recorded when money is received.
  • You can’t do both. You have to choose one.
  • Most people choose accrual.

• SAVE THE EVIDENCE — You need to save contracts, receipts, invoices, bank statements… anything that is evidence of money in and money out.

• USE A SYSTEM — You need to have a clear, organized system in place.

  • At the bare minimum, use a spreadsheet.
  • It’s worth it to use financial management software like Quickbooks.
  • It’s best to use something like Quickbooks + working with an Accountant.

Part 2

Financial Planning

Now that you have the money, what do you do with it?

In terms of simplicity and accuracy to creative practices, I really enjoy this article from the Creative Independent:

An Artist's Guide to Financial Planning

From the article, we're going to cover two items: Budgeting and Investing.

Budgeting

• Budgeting is about short term financial security
• From the article: The 50 / 30 / 20 Budget

A 50/30/20 budget is based on three simple categories:

• Obligations: how much you have to spend (50% of your income)
• Discretionary: any time you pay for a thing out in the world (30% of your income)
• Savings: the money that you don’t spend each month, which is building up your financial security (20% of your income)

Investing

In other words, getting your money to make money.

• Investing is about long-term financial security (i.e. retirement)
• Investing takes advantage of the positive aspect of generating interest on a principal.
• Compounding interest isn’t just about debt. You can utilize it to invest and make much more money.
• Investing is pretty easy to do these days, but should always be done with a healthy dose of caution and advice.

For example:

• You decide to save $500 per year.
  • If you invest in a retirement account— In 30 years, you will have $54k (7% interest)
  • If you don’t invest, but just save — In 30 years, you will have just $15k

Section 3

Introduction to Taxes

Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.

— Benjamin Franklin, in a letter to Jean-Baptiste Leroy, 1789

Y'all, we ain't dead yet. So we gotta pay taxes. What we're going to cover in this section are all income taxes.

The Internal Revenue Service defines income tax as:

Taxes on income, both earned (salaries, wages, tips, commissions) and unearned (interest, dividends). Income taxes can be levied on both individuals (personal income taxes) and businesses (business and corporate income taxes).

Parts
Tax Levels
Tax Rates
Employee vs. Self-Employed
Business Deductions
Filing

Part 1

Income Tax levels

There are three levels of taxes to be aware of: federal, state and local. What's more fun, each of these taxes are imposed by different legislatures. In the US government, the legislature has the power of the purse—so taxes are created within that branch of government.

1. Federal

These are the taxes you owe to the federal government, regardless of which state you are in.

Governing legistlature: The U.S. House of Representatives.

Who To Complain To About Taxes:

• Your Representative for your Congressional District — Find My Representative

2. State

Taxes levied by the specific state in which you either reside or earned income within. If you are doing business in multiple states, you may be responsible for filing multiple state tax returns.

Governing Legislature: State House of Representatives

Who To Complain To About Taxes:

• Your STATE Representative for your STATE district.

3. Local

This may include county, city, and specific township taxes (like school districts)

Governing Legislature: This is very specific to where you are. This may be a City Councilmember for an urban area or a county rep for a more rural area.

Who to Complain To About Taxes

• Again, it's specific to where you are but usually addressing issues at the county level is the most useful.

Part 2

Tax Rates

Individuals

• Every individual in this country that earns money must pay income tax.
• There are other specific taxes, but we’re going to focus on income tax as it’s the most relevant.
• For tax rates, let’s visit the [IRS](https://www.irs.com/articles/2018-federal-taxrates- personal-exemptions-and-standard-deductions)

Corporations (and Non-Profits)

• Corporations are considered “people” — i.e. they have to file their own taxes independent of the individuals who run them.
• In the interest of time and sanity, we’re not going to cover corporate taxes. Just remember that they are in addition to personal income tax.

In the United States, income taxes are levied using a system of marginal tax rates.

This video from Vox best explains how these tax rates work:

Here's a look at the 2020 Marginal Tax Rates:

Rate	For Single Individuals	For Married Individuals Filing Joint Returns	For Heads of Households
10%	Up to $9,875	Up to $19,750	Up to $14,100
12%	$9,876 to $40,125	$19,751 to $80,250	$14,101 to $53,700
22%	$40,126 to $85,525	$80,251 to $171,050	$53,701 to $85,500
24%	$85,526 to $163,300	$171,051 to $326,600	$85,501 to $163,300
32%	$163,301 to $207,350	$326,601 to $414,700	$163,301 to $207,350
35%	$207,351 to $518,400	$414,701 to $622,050	$207,351 to $518,400
37%	$518,401 or more	$622,051 or more	$518,401 or more

Part 3

Employee vs. Self-Employed

Employees

• If you’re an employee, the income you receive is a Salary or Wage.

Self-Employed

• If you are Self-Employed, your income is all considered Business Income.

The reason we need to cover these definitions again is because of a tax in addition to income tax: Employment tax. This tax pays for both the Social Security and Medicare programs.

• For Employees, these taxes are taken care of by your employer.
• For Self-Employed income, YOU have to pay these taxes.

1. Filing taxes as an Employee

• Relatively straightforward.
• You receive a wage or salary from an employer.
• Your employer withholds money from your paycheck for things like social security and medicare.
• Your employer will send you a W-2 that outlines your earnings and what was withheld (subtracted from your pay and sent to the government).

2. Filing Self-Employed Income

Not so straightforward…

First, there are two major considerations:

1. Hobby vs Business

2. Business Structure

1. Hobby vs. Business — Does the government consider your practice a hobby or a business?

• Are you making a profit? Yes? — Probably a business
• Does the profit represent more than 2% of your income? — It’s a business
• If it’s a business, you have to report the income to the IRS and pay taxes.
• If it’s a hobby, you normally don’t.

2. Business Structures — The type of business structure affects the types of taxes you pay.

• Sole P — Everything is considered one income.
• One-member LLC — The IRS treats you like a Sole P. It’s all one income.
• Partnerships — You pay income tax for the % of the partnership you own.
  • For example, if you own 10% of the partnership, you pay income tax on that 10% of the profits.
• Multi-Member LLC or S Corp
  • An LLC can be a pass-through (Works like a Partnership)
  • Or you can be your own employee (Pay both personal income tax and corporate tax for the LLC)

The tax implications of Employee vs. Self-Employed are pretty major

Employees:

• You just pay income tax — Usually the marginal rates of 10%, 12% & 22% on your taxable income.
• Your Employer has already taken care of the employment taxes:
  • What they withhold is the part what you pay into social security and medicare: Approx 7.5%
  • They also have to pay into social security and medicare: Approx 7.5%

Self-Employed:

• You pay income tax PLUS the employment taxes.
• That’s the marginal income taxes (10%, 12%, 22%) PLUS Self-Employment Tax of approx. 15%
• Your tax burden could be almost 27-37%.

Let’s look at a tax calculator…

Part 4

Tax Deductions

What is considered taxable income essentially just refers to your profits.

• Remember from Finance Basics: Income - Expenses = Profits
• Deductions reduce your taxable income.
• So, in a way… Yearly Income - Deductions = Taxable Income
• The lower the Taxable Income, potentially the less taxes you have to pay.

There are three types of tax deductions to be aware of:

1. Automatic Deductions
2. Applied Deductions
3. Business Deductions

1. Automatic Deductions

First, there are certain categories that the government will automatically not tax, therefore lowering your taxable income.

These include things like retirement account contributions.

2. Applied Deductions

Then we have to apply deductions for personal income taxes. There are two methods for applying deductions: Standard and Itemized

— Standard = An set amount of money you get to automatically deduct.

• The government determines what this amount is.
• What’s your standard deduction? Back to the IRS site!

— Itemized = Listing out and adding up each individual deduction you qualify for.

• If your itemized deductions are less than the standard deduction, you have to use the standard deduction.

For personal income, you can only pick one method: standard or itemized. Pick the one that saves you the most money.

3. Business Deductions

These are deductions that, for self-employed income, you apply in addition to your personal deduction.

What are deductible business expenses?

Here's a short list:

• Materials and supplies
• Studio expenses (rent + utilities)
• Advertising
• Travel
• Vehicle expenses
• Fees paid (To enter competitions, fairs, etc)
• Vendor fees (paypal, etc)
• Contract fees (That you pay to other contractors)
• Large equipment (Like a laptop, table saw, welder, loom, etc)
• Legal and professional services (Lawyers, accountants, etc
• Repairs and maintenance (of things like your equipment)
• Cell phone costs
• Education costs
• Conference expenses
• Relevant cultural events
• Books, magazines and reference material
• Film and processing
• Framing
• Home office expenses
• Software subscriptions
• Business insurance expenses
• Business meals
• Business gifts
• Office supplies
• Taxes (other than income tax)
• Tax preparation fees
• Postage
• Couriers
• Internet

Itemizing expenses in creative practice

$5,000 (earned from a sale of artwork)
	MINUS
$4,000 (Deductible expenses used to create the artwork.)
	EQUALS
$1,000 (Taxable Income)

INCOME TAXES THAT APPLY: 12% Income + 15% Self Employment

	— WITH BUSINESS TAX DEDUCTIONS, YOU PAY TAXES ON ONLY THE PROFIT: $270

	— WITHOUT DEDUCTIONS, YOU PAY IN INCOME TAXES ON THE FULL AMOUNT: $1,350

​

Part 5

Filing

Regular Employees: Once a year

Self-Employed: Quarterly

I'm going to cheat and just refer all of you to this excellent article on how to do your taxes as an artist. The author does a far better job than me explaining how the various forms and filing work:

A smart artist’s guide to income taxes · The Creative Independent