Episode 139: Minimizing the Tax Liability for Your Consulting Business—with Octavia Conner
Deb Zahn: I want to welcome you to this week's episode of the Craft of Consulting Podcast. On this episode, we're going to talk about money and taxes because tax season is coming up. It's the end of the year. You should be looking forward to next year and saying, “Hey, what kind of profits do I want to be making in my consulting business?" So I brought on just a fantastic guest, Octavia Conner, who's from Say Yes To Profits, which is the perfect title for what we're going to talk about.
And essentially, we dive into the legal structure and the type of things that you need to be looking at in terms of your finances to ensure that you are not just profitable, but you have good cash flow coming in. And you minimize any liabilities or any ways that you're reducing your income, and you're making sure you get as much as possible in your pocket. So many golden nuggets in here.
Let's get started. I want to welcome to my show today, Octavia Conner.
Octavia, welcome to the show.
Octavia Conner: Thank you. Thank you so much for having me.
Deb Zahn: You bet. Well, let's start off. Tell my listeners what you do.
Octavia Conner: Well, I am Octavia Connor, CEO of Say Yes To Profits. We are a virtual CFO firm and our focus is helping consultants gain financial clarity and control and build profitable million-dollar businesses.
Deb Zahn: I love that. So we're going to dive into some of that today, and we're actually going to talk about two topics and particularly things that have tax implications, which everybody's got to care about because tax season is coming and you want to make good choices. So let's start off because a lot of folks when they become consultants, particularly independent consultants, don't necessarily think of their legal structure as something that has tax implications. And I know you know that's not true. I know a lot of folks ask, “Should I be an LLC? Should I be S-Corp? Should I be a sole proprietor?” What's the difference between those and what do you see as some of those pros and cons of each?
Octavia Conner: That's a great question. So a sole proprietor is basically the consultant working as themselves. There are not really any tax benefits to being a sole proprietor. An LLC is a limited liability company. Now, from a federal perspective, it's considered or seen as a disregarded entity. Meaning the business owner and the business is one and the same from a federal level. From most state levels, it is considered a separate entity from the business owner.
And then you have an S-Corporation. And an S-Corporation is a separate corporation in itself from the business owner and the business owner under S-Corporation has to be an employee of the company. As an LLC, the business owner cannot be an employee of the company, and as a sole proprietor, again, the business owner and the company is one and the same.
Deb Zahn: And so, if you're trying to, which I know you do love to help people maximize their profits, which direction would you go?
Octavia Conner: Well, that's a great question and it depends on a couple of different things. Most consultants want to be an LLC to start. Once the business is generating a net profit, the bottom-line number, when they look at their profit-and-loss statement, the number at the very bottom. Once the company is generating a net profit of at least $40,000 for the year, they want to consider being an S-Corp. Why? Well, as an LLC, you’re taxed at 15.3% of your next net profit. As an S-Corp, when you become an S-Corp, there are no taxes levied on the business, but the caveat here is that you have to be an employee so then your salary becomes a tax deduction.
Deb Zahn: Interesting. So I might have to personally listen to this a few times because I'm still an LLC. So it comes tax time, somebody started as an LLC as a consultant and then they're going to switch to an S-Corp and the taxes work differently. How much have you seen folks have been able to actually keep in their pocket as opposed to sticking with what they got?
Octavia Conner: Oh, my goodness. We have seen savings anywhere from like $22,000 and up. Yes.
Deb Zahn: She's looking at my face. My jaw just dropped.
Octavia Conner: Yes.
Deb Zahn: Wow.
Octavia Conner: Because, listen, let's do the math. So we said $40,000. Take 40,000 times 15.3%, that's $6,120 that you will have to pay at a minimum, now, this is just the minimum to the IRS. And I often tell business owners, especially consultants, did the IRS help you build your business? Why are you willingly giving them six, seven plus thousand dollars? When you become an S-Corp, you pay zero on that $40,000. But again, you have to be an employee of the company. So we've seen savings upward of $22,000, $20,000 plus. We've seen savings as little as $5,000$, 6,000. But again, this is money that you're saving that you can keep in your business, instead of having to give it to the IRS.
Deb Zahn: Wow. And that's not chump change. So that's really, really helpful. And sole proprietors, you want to tell them something?
Octavia Conner: Sole proprietors are primarily based on the business owner's tax rate and other factors like any other write-offs or things that they have. Ideally, sole proprietors, you're giving your money away to the IRS. And honestly, the amount that you could be giving away in one year is upwards of five figures or more, just depending on how much money you brought in and how much has went out in your business, and your personal, rather, for that year as a proprietor.
Deb Zahn: Love it. And what I love that you're saying, and I know you talk about this on your show is this is a way to scale your income without killing yourself, trying to work more and more and more to generate an additional five figures in your pocket.
Octavia Conner: Right, just to give it to the IRS.
Deb Zahn: Wow, that's really helpful. So let's dive into the finances part because I guarantee I'm making mistakes. I guarantee it. So anybody listening, don't worry, you're probably making some of the same mistakes that I am. If a consultant understands that they are in the business of consulting, so they're not just sharing their goodness and their expertise with the world, but it is a business, what are the things that they should be looking at from a financial perspective on a regular basis? And why should they be looking at those?
Octavia Conner: Now, this is a great question. I have several. So one, I would say would of course be your revenue per client or your average revenue. What is the average amount you're bringing in per project or per client? You also want to determine your cost per client and per project. Understanding these two will help you identify your profit margin per client or per project.
Deb Zahn: Nice. And this is where it's probably sobering, where there might be some clients where you could work at Burger King and work more.
Octavia Conner: Yes, exactly, exactly.
Deb Zahn: Great. So you would take that you would look at it and say, "OK, now what choices am I going to make about who I'm going to work with, my expenses, et cetera?" Love that. What else am I looking at that I know that I'm actually a profitable business?
Octavia Conner: You also want to look at your revenue per billable consultant. So the number of consultants that are working for you and how much revenue you're earning per billable consultant, as well as per billable team member. Because if you have team members where they're not contributing to the revenue generation of your consulting firm, are they really helping you? That's the question. And sometimes we have team members that are really not helping us, but we think that they are.
Deb Zahn: That's right. And if we don't look at it, we don't know.
Octavia Conner: Absolutely.
Deb Zahn: Now, I know one of the things that you love to talk about is net profit versus your bank balance. And so, explain what's a common mistake that folks are making with those and then what should they do instead?
Octavia Conner: A common mistake is thinking that the number on the bottom of your profit-and-loss statement, which is your net profit, will be the exact same number that you see when you log into your bank account. And then you log into your bank account and you're like, "OMG, what is going on?" Because I see this $30,000, $40,000 upwards of a net profit, and then I see $5,000, $2,000, or a negative bank balance. So that is a common problem. And one of the things that business owners want to do is to make sure that, of course, that you generate a net profit, but you keep track of your bank balance, which will include things that are not showing on your profit-and-loss (P&L) statements.
Deb Zahn: Interesting. So what are some of those things that it would show that you wouldn't see on your P&L?
Octavia Conner: So if you made any investments into your company, as the owner, that is going to actually show on your balance sheet because your profit-and-loss statement will only show your income, your cost of goods or services sold, and your expenses if you made a credit card payment. So your credit card expenses, for example, the things that you use your credit card to purchase will probably be on your profit-and-loss statement. But the actual payment, meaning money came out of your business to pay the bill, that's not going to be on your profit-and-loss statement. That's going to be on your balance sheet and that will affect your bank balance, not your profit and loss.
Another great thing to track is your account's receivables. Let's say that you've invoiced several clients and on your profit-and-loss statement, it shows that you earned this money. So now you have a net profit, but what if the client hasn't paid the actual money yet? That means it hasn't hit your bank balance. So you're counting on this money, but it's not there. So you want to track your net profit, as well as your bank balance consistently. Another thing that will not show would be loan payments. So if you have any loans or you're receiving grants, that money is not going to show on your profit-and-loss statement. But when you make that loan payment, it's going to show on your balance sheet and it's going to affect your bank balance.
That's why I often say to have a healthy business, you must have a healthy balance sheet. The profit-and-loss statement is important, but the balance sheet and the cash flow statement, those are criticalA and they must be healthy as well.
Deb Zahn: I love all of that. And I will give an example of accounts receivable. So especially folks who look at things on an accrual basis and not a cash basis…
Octavia Conner: Absolutely.
Deb Zahn: ...is they'll be like, "Oh, yeah, great. I sent this invoice for $20,000, $100,000 for this project I was working on." And it feels like you've made that, but you haven't made it until it's in your bank. And there are some clients, it doesn't matter what the contract says, will pay you late. I've heard from other consultants that a lot of the big companies because they don't have to, and they know it, will pay very late. Government contracts tend to take a really long time. And if you work for any academic setting, you might actually forget about that payment before you actually get it in your hands. And so, this is where you might "have it," but you're not going to have the cash flow and cash flow is what pays the bills.
Octavia Conner: Absolutely. You are 100% correct. And accounts receivables often opens consultants to having what I call a cash gap. So you have a period in which you've sent out an invoice and you're like, "Yay, money, I have money!" However, the gap begins because even though you sent the invoice out, that doesn't mean that they're going to pay the invoice. But within that gap, you may have to pay your team members. You have daily operation expenses that are still going out, and yet you're waiting on this money to come in. And then what if they're late 30 days, 45 days, I've seen even up to 90 days where you're waiting on money, but yet your profit-and-loss statement shows a net profit. And then you log into your bank account and you're feeling stressed financially. You're feeling defeated. You're feeling scared, but you haven't focused on the balance sheet, the bank balance, the AR, and cash flow.
Deb Zahn: Yeah. And when consultants first start, and this is all a mystery to them, they're going to hang up their shingle, which dates me. But I'll just hang up my shingle and then I'll get clients and I'll get money coming in. What do you think the first, most important things they should set up financially so that they actually don't have to wonder what's going on?
Octavia Conner: Their financial foundation. And their financial foundation consists of having an accounting system. A system where they are entering all of their expenses and all of their income. A system that allows them to constantly see what invoices have been sent out, have been opened, viewed, or paid. So that way they're constantly keeping track of this information. Regardless of what their financial reports state to them, they know exactly where they stand because they have an accounting system in place.
Now, their accounting system must be accurate and up to date come consistently, at a minimum, at least once a month, at a minimum. I recommend weekly. And we even update our client's file every single week, sometimes two or three times a week, depending on the volume for that client. But at a minimum, once a month.
Deb Zahn: So don't have a shoebox where you're keeping all of your receipts. I wish everybody could see your face right now. And then you enter it at the end of the year. So don't do that.
Octavia Conner: No, don't do that. Let me tell you why. You have missed out on so many financial strategies and things that you can implement. When you wait towards the end of the year, you're like, "OK, what is my tax liability going to be," instead of proactively preparing for those things. If you wait till the end of the year, you're at the end of the year and realize that someone in January or February still hasn’t paid your invoice and you still have money out there. Or you're waiting until the last minute to basically do nothing but realize that I waited until the last minute and I left all this money on the table or I gave unnecessary money away.
Deb Zahn: Yeah. And I've seen where somebody's gotten back to a client, realizing that they didn't pay their invoice at the first of the year. And then the client said, "Our fiscal year's over, what are you talking about? I never saw that invoice." So I love that. And I know that this can be really daunting for folks, particularly when they're just trying to get money in the door and they get so excited when it happens. But when they start to build their pipeline of work, so they start getting multiple clients over a period of time, that's where the budget versus forecasting comes into play. Talk about how that works and what folks should be doing.
Octavia Conner: So that's really great that we're touching on that. A budget is a plan. It is a best-guess estimate of what you desire or plan to happen in your business. A budget often only focuses on your income and your expenses for your business. So for example, you're planning to earn a certain amount per average in income and you're planning to have X amount go out in expenses. So this is your projected or planned net profit.
A forecast positions consultants to be proactive instead of reactive with managing their cash flow. Cash is your firm's superpower. When you create a forecast, you're not only looking at revenue and expenses, but you're also forecasting any owner’s investments, partners’ investments, you're forecasting any payments you're making to yourself. Because remember, as an LLC. You're not a W2 employee. You're just basically paying yourself money from your business. So that's not going to show up on your income statement. But a forecast, looking at the money that you're taking out, you're looking at payments that you're making to credit cards or loans. You're looking at all the ways, and you're forecasting all of the ways money will enter and exit your business.
Deb Zahn: And if you don't see any money at certain places, now you can make a plan for it. So when you're working with folks and you see bumps and lumps along the way and dry spells and all of that good stuff, what do you help them with to get it so that not only do they know, but they have more steady profits as they go along?
Octavia Conner: So when we are with consultants, we often look at a 13-week cash flow forecast. So it allows us to look 13 weeks ahead of time. And we are looking for those weeks, those days where cash is few and far between. When we find those times, there are a couple of different things that we deep dive into. From the onset, we look at pricing, are you priced for profits? That is highly important. We're also looking at your sales conversion. Your sales conversion, meaning, are you converting 50% of the leads that comes into your company? You are? Great. You want to sign five new clients. Well, that means you need 10 new leads because your conversion rate is 50%. So we're 13 weeks out, how can you make sure that over the next 13 weeks you speak with 10 new potential clients?
Another thing that we focus on is your service model. Oftentimes, consultants think, well, to build a million-dollar business, I have to have 13 services, 12 products. I have to have all of them in the marketplace. And I often say, “No, you really don't.” You need signatures, as I call them. You need a signature service that you're going to focus on, that you're going to try to make sure all your potential clients know about that service. And you need your signature client. Who is your million-dollar client? You want to get crystal clear on both of those. So those are just some of the things that we often focus on to make sure that our clients remain cash flow positive.
Deb Zahn: I love all of that. And I really love looking at conversion rates. And I've seen this where folks go out, and they do a whole bunch of outreach. Or they generate leads, and they're trying to turn them into prospects and clients. But they aren't paying attention to conversion rates. And then when they stop and look at it, they're converting 10%. That tells me that you're not having the right conversations with the right people because it's hard to build a business off a low conversion rate. You're going to be doing all this stuff all the time that nobody's paying you for.
Octavia Conner: Absolutely. That's why you have to know your signatures. Yeah. Your signature million-dollar client who are the clients that you enjoy working with, that often work with you the most, that often will invest in that million-dollar on your signature service or products? You have to know their characteristics, where you find them or where they find you at. Those are things you must know to make sure that you have a 50% or better conversion rate. And because when you do, it results into more cash in your business.
Deb Zahn: Absolutely love it. So as we're coming towards the end of the year here, what are you talking to folks about as they head into the new year? What should they be paying attention to?
Octavia Conner: I believe that consultants should build out their million-dollar plan for next year. And there are a couple of components of the million-dollar plan. The first component is their financial foundation, going back to making sure that the accounting system is in place, making sure that you're crystal clear on your payment terms. A lot of consultants will have, not due upon receipt, they will have due in 30 days. But why? Who will say that it has to be due in 30 days? Why do you have to wait 30 days to get your money?
Deb Zahn: That's right.
Octavia Conner: I believe in due upon receipt or you have your payment stagger according to the project. So a deposit in the beginning, a deposit halfway through, and a deposit right before you're done. So I would say the first thing would be making sure that you have a solid financial foundation that by a click of a button you know where you stand financially in your business.
The next thing would be, I call it the profitable million-dollar plan. This plan includes your signatures. This plan includes how you're going to execute your money. So when money comes into your business, what is it supposed to do? What is the money assignment? Oftentimes, consultants will have money come in, or they'll spend it before it even hits their bank account. You should tell every dollar you have earned or you expect to earn what to do because when you don't tell it what to do, it's going to tell you what to do.
Deb Zahn: That's right. That's right. You are the boss of the money coming in. Don't make it the boss of you.
Octavia Conner: Yeah, exactly. And then another thing I would say would be accountability. And accountability includes that budget and forecast that we talked about. Accountability includes your money team and metrics. What are the metrics? What are the things, the key performance indicators and the numbers that you must watch in order to know how to grow your business? And we talked about one earlier, your sales convergence.
Deb Zahn: That's right.
Octavia Conner: I usually have my clients have about five key performance indicators that they're watching constantly, that they know if they do this, versus that, it will equal more money and more profits in your business.
Deb Zahn: I love that. And if their key performance indicators slip, then now they know what to do.
Octavia Conner: Yep. Yep, and that's the opposite effect. Now you know exactly what you must do or stop doing, in order to shift the financial trajectory of your firm.
Deb Zahn: I love that. And I'm really glad you brought up pricing, including redoing potentially your pricing because you might have fallen into an underpricing trap. Maybe I switched a few of my clients to retainers and I get paid first and I do great stuff for them. They get everything that they need. They love it because they don't feel a clock ticking behind them and I get paid at the beginning of the month.
Octavia Conner: Absolutely, 100%.
Deb Zahn: Which we got to love that for cash flow.
Octavia Conner: Yeah, absolutely. Instead of waiting 30 days, 60 days, 90 days, you're getting paid upfront and you're providing excellent services and value to your clients.
Deb Zahn: That's right. And it's predictable for them. They know exactly what their expense is, it's a beautiful thing. So if you were standing in front of a client, who's in those first two make or break it years and they're just trying to get clients, they're trying to make it work, they're trying to bring in income, what's your top piece of advice for them? I know it's hard to pick one.
Octavia Conner: I would say, focus on your earning potential. What is your earning potential? How much money can you bring in at the fastest way possible to build a million-dollar consulting firm?
Deb Zahn: Love it, love it. And when they step back and they're like, "Wait a minute, I kind of like this idea that she wants me to have a million-dollar consulting firm," which is definitely possible, how do you handle it when folks just don't believe it?
Octavia Conner: So that's a money mindset. And it could be because of there are money blocks or honestly, things that have happened as a kid, as they were growing up that are affecting them as an adult. So one of the things they would have to do is fix their money mindset. Identify those thoughts and those actions that are resulting in not believing in themselves, that are resulting in not working to their fullest capacity in order to earn more money faster.
They have to get crystal clear on their money mindset in order to build a million-dollar business, in order to have more money come in their business, in order to keep more money coming in their business. They have to make sure that they are clear on their money mindset and that they are clear on the money blocks and they're fixing the money blocks.
Deb Zahn: That's right. And they don't see it at odds with the service mindset. It can be the same thing. Mission plus margin.
Octavia Conner: I like that. Absolutely.
Deb Zahn: I didn't make that up, but I love that one. I tell my nonprofit consulting clients. “Yes, you're not supposed to be a for-profit entity, but the more margin you have, the more good you can do.”
Octavia Conner: Right. Exactly.
Deb Zahn: Wonderful. So where can folks find you?
Octavia Conner: Well, everyone can find me on YouTube. We do a weekly video on YouTube at Say Yes To Profits, as well as on Instagram, we're always on those two platforms. We're on LinkedIn and Facebook as well, but our primary two are YouTube and Instagram.
Deb Zahn: And your YouTube videos are fantastic. I can easily say, go and check them out. I learned a lot by watching them. So let me ask you this last question, and you know this is coming, which is how do you with all this good stuff you're doing bring balance to your life, however you define that?
Octavia Conner: I take breaks often. So I love massages. I love spending time with my family. I have four kids. I have a husband. So I often just get away. I love Say Yes To Profits and all things Say Yes To Profits, but sometimes I have to go away, close the door, get a massage, drink a glass of wine, and just say, you know what, it's all about Octavia today.
Deb Zahn: That's right. Say yes to Octavia.
Octavia Conner: Yes, absolutely. Those are days that I have. And honestly, I make sure I have those frequently.
Deb Zahn: You must. That's the only way I know how to build a sustainable profitable business is to do that. Well, Octavia, I'm telling you we could go on and on because I know that we just scratched the surface on really how to get to the profit side of the business, but I want to thank you so much for coming on and sharing your wisdom.
Octavia Conner: Yes. Thank you for having me. This was super exciting and so much fun. I love when I'm given this opportunity, so thank you very much.
Deb Zahn: You bet. Thanks so much for listening to this episode of the Craft of Consulting Podcast. I want to ask you to do actually three things. If you enjoyed this episode or if you've enjoyed any of my other ones, hit subscribe. I got a lot of other great guests that are coming up and a lot of other great content and I don't want you to miss anything. But the other two things that I'm going to ask you to do is, one is, if you have any comments, so if you have any suggestions or any kind of feedback that will help make this podcast more helpful to more listeners, please include those.
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So as always, you can go and get more wonderful information and tools at craftofconsulting.com. Thanks so much. I will talk to you on the next episode. Bye-bye.