Budgeting and Financing
This article will be of interest to self-employed artists. It aims to provide guidelines on how to manage and control the day-to-day finances associated with their work. What follows describes what a hypothetical artist, Karen, should do once she has finished at art college and has started exhibiting and selling her work. Karen should keep separate in her mind and in practice the finances associated with her personal life and the finances associated with her business of creating and selling art. In many cases, it is easy to determine whether an expense is ‘personal’ or ‘business’. In other instances this is not straightforward, particularly where a payment – e.g. for electricity or travel – may be partly business and partly personal. A key aspect to identifying and quantifying this differentiation is to adopt a systematic approach to keeping records and to preparing and reviewing budgets.
Banks and Bank Accounts
Karen has had a bank account for several years. She should continue this account to deal with her personal finances. However, she should open a separate account to keep track of her business transactions. To avoid confusion, this account should have a slightly different name. For instance, ‘Karen – Business Account’.
Banks are businesses established to make money for their owners / shareholders. They do this by borrowing and lending money and providing associated financial services. Banks borrow money (receive deposits) and pay the lenders (those from whom they borrow) a fee (interest). Banks also lend money and charge the borrowers a higher rate of interest. The difference in the two rates of interest reflects their profit.
Banks compete with each other, often quite aggressively, by offering different rates of interest and different types of service: just as supermarkets compete with each other by varying their prices. Like shops, in order to survive banks (money shops) need a continual supply of new customers. Karen should never feel intimidated or over-awed by the bank she deals with. She should regard it as she would any other shop. It is in the bank’s best interests to help and facilitate Karen to the greatest possible extent. After all, it needs her business. If she is not satisfied with the service, she has the option to go elsewhere.
When setting up her business account, Karen should tell the bank staff about her work as an artist. She might give them a copy of her graduation certificate, exhibition catalogues and other information about what she is doing. As time goes by, she should keep the bank informed about how her business is progressing. This will help the bank to build up a profile of Karen. She will become more than just an account number. So, when Karen needs financial assistance – such as a loan to develop her business or a mortgage – the bank will be all the more ready to help her and, she hopes, offer preferential terms. Karen probably already has a good personal relationship with other providers of services she needs regularly – her doctor, hairdresser, shops etc. For precisely the same reasons she should seek to build up a personal relationship with her bank.
Having separate bank accounts will help Karen to keep the financial aspects of her life separate and distinct. It is essential that Karen use her business bank account only for transactions that relate entirely or mainly to her business. Similarly, her personal bank account should be used only for transactions that relate entirely or mainly to her personal life. Some financial transactions will relate to both parts of her life. Perhaps her studio is a room in her home. When she goes on holiday she takes the opportunity to visit studios and exhibitions in other countries. From time to time she uses her partner’s car to deliver her works and pick up materials. It is usually best to use her business account to pay for items which relate to both parts of her life. Keeping clear records is key to maintaining clarity and avoiding confusion.
Inevitably, there will be a good deal of paper associated with financial transactions. The issue for Karen is either the volume of paper overwhelms her or she controls the paper!
Karen needs to keep all financial documentation systematically filed, for the following reasons:
* To make sure that no business expense is overlooked.
At the end of each year, Karen will probably hand her financial records to an accountant, who will prepare an account to show how things are going, financially, and to prepare her tax return. The accountant will aim to maximize the level of Karen’s business expenses and so keep her profit for tax purposes as low a figure as possible. It is the small expenses that many people, especially those self-employed, tend to overlook.
* To keep the accountant’s fees to a minimum.
Fees tend to reflect the time spent on a job. The more systematically Karen keeps the documentation, the less time the accountant will need to spend preparing her accounts.
* To minimise the length of time she spends on accounts work.
Karen’s business is creating art. She does not wish to spend more time than absolutely necessary on dealing with her finances. A systematic filing system reflects effective time management and will enable Karen to concentrate on the core part of her business.
*A simple method of filing accounts records is to have five lever-arch files.
They should be labelled ‘Bank’, ‘Credit Card’, ‘Payments’, ‘Receipts’ and ‘Tax’ (Note: the term ‘receipt’ has two meanings: it can refer to either a document or a sum of money. See section entitled ‘Some Definitions‘).
The BANK file will hold bank statements and other paper-work from the bank. Karen should ask the bank to send her a statement at least once a month and she should ensure that she understands all the information on the statement – there is a surprising amount. If Karen is unsure about anything, she should ask the bank to explain. They will be glad to do so.
The PAYMENTS file will hold paper relating to all payments (other than credit card transactions) made in the course of Karen’s business. She should make as many payments as possible by cheque or by electronic funds transfer from her account. Inevitably, some payments will be made by cash.
Every payment relating to goods or services purchased in connection with Karen’s business as an artist, no matter for what, how made, or for how little, must be supported by a corresponding piece of paper.
This may be an invoice given by the supplier with the goods, a receipt, a checkout slip from a shop or simply a note scribbled by Karen, dated and saying what the payment was for. For instance, Karen may pick up stationery while she is in the local supermarket. She should keep the receipt, highlight the items purchased for business use and place it on the file. Karen should not forget to include bus, tram and train tickets, parking meter tickets, receipts for books and other art publications. If she travels in her partner’s car on business, the date and kilometres travelled should be noted on the file. If the payment is for a domestic utility such as electricity, gas or telephone, Karen should place the associated bill on the file with all the others, leaving to her accountant the job of determining what proportion relates to business use. If the documentation relates to a cheque Karen has written, she should write the cheque number and date in the top right hand corner. Payments by laser card are debited to the bank account so should be documented the same way as payments by cheque. If cash is withdrawn, for whatever purpose, Karen should write a brief note saying for what purpose the cash was needed. If there is cash over, it should be re-lodged and entered on the Receipts side of the analysis book.
CREDIT CARD statements should be kept in a separate file. Karen should keep all the credit card purchase receipts and staple these to the back of the relevant statements.
The RECEIPTS file will hold paper relating to all money received (receipts) in the course of Karen’s business. Most receipts probably will relate to works sold by Karen. She should give a sales invoice to each purchaser and place a copy on the Receipts file. When payment is received, the copy invoice should be ‘marked off’ with the date of the receipt. Karen may give occasional lectures or talks. Any documentation received with cheques in payment of fees should be filed.
The TAX file should hold all material received from the Revenue Commissioners / Inspector of Taxes. Also, if Karen has PAYE income from a part-time job, P45s, pay slips and P60s should be kept here.
From time to time, Karen will need financial advice on some aspect of her business, so she should engage an accountant. She should seek recommendations of suitable persons from her colleagues in the art world. Ideally, her accountant should have knowledge of and sympathy for the arts sector. As already mentioned, at the end of each year the accountant will prepare an account and file a tax return. This must be done, even if Karen has been granted artist’s exemption from income tax. If the return is late, Karen will be liable for financial penalties.
Analysing Payments and Receipts
Note: The following is an outline of a simple receipts and payments analysis system, maintained manually. This outline is intended as a pointer to what needs to be done. It does not cover all aspects of the process. Those who wish to set up a system are strongly advised to seek advice from an accountant or accounting technician.
As her business develops, from time to time Karen will want to know how things are doing financially. Is she paying her way? Is she making a profit or a loss? She needs to make a profit to support herself financially. Many of her friends will be in employed positions and receive a regular pay cheque. Self-employed persons, such as Karen, earn a profit. In simplest terms, a profit is total business expenses for any given period minus total business receipts for the same period.
At the end of the year, the accountant will calculate Karen’s profit. However, during the year, Karen can obtain a fair idea of how her business is doing financially by analysing in a systematic way the payments and receipts referred to previously. There are simple accounts software programs that will help her do this. Initially, however, Karen may find it more convenient to do so by hand. For this she will need a Receipts and Payments analysis book. Receipts (money in) are recorded on the left-hand page, payments (money out) for the same period on the right-hand page. Each page has the following columns:
- Date of Transaction: When the money is received or payment is made.
- Details: Names of those from whom money is received / to whom payments are made
- Reference: A narrow column for a reference number. e.g. cheque number or bank statement reference
- Total Column: The first cash column is generally used for the total value of the receipt or payment
- Other Columns: The remaining cash columns are used to analyse the total amount under various headings appropriate to the business
A well-designed analysis book (also called a ‘cash’ book) will tend to have a greater number of columns on the right (for analysing payments) than on the left (for receipts). Karen should ensure that there are plenty of analysis columns provided for payments. An artist’s Receipts and Payments analysis book might have the following financial columns.
At the bottom of each page, Karen should add up all the columns and check that the total of money columns… 2, 3, 4 …equals the total of the first money column 1. She then should carry forward all the totals to the top of the next page. It is probably best for Karen to continue carrying forward the totals to succeeding pages until the end of her financial year (usually 31 December). This will enable her from time to time to compare her actual receipts and payments against her budget for the year (see section on budgets).
It is important to note that the transactions recorded in an analysis book such as that described above should relate to one bank account only. If there is a second bank account, then a second analysis book should be used.
Click to see what a page from an analysis_book may look like. In this example there are two receipts columns and a total column and four payments columns and a total column. In a real situation, there might be four receipts columns and maybe nine or more columns for analysing payments.
Other options for analysing payments and receipts are:
*to use an EXCEL computer spreadsheet
* to use accounting software.
When using manual analysis books, some categories of payment may have to share the same column. The use of spreadsheets and accounts software avoids this.
Working with Cash
Karen should aim as far as possible to make all payments by cheque, laser or credit card. It can be time consuming to have to deal with cash and record cash transactions properly. Inevitably, Karen will occasionally make minor cash purchases using her personal, non-business money. Whenever she does this, she should immediately refund herself with a business account cheque and place the documentation on the Payments file.
If her business involves selling items for cash, she will need to put in place additional procedures. These will ensure that details of cash received are fully recorded and that money is lodged regularly to her business account.
Karen should never use cash received from selling her work to buy items for her business. To do this can lead to confusion and distorts her financial records. It adds to the amount of work her accountant must do at the end of the year. If cash is needed, draw it from the bank account, not from cash receipts.
No matter what the nature of the business, the rule is ‘Always lodge cash receipts to the bank gross, that is without using any of it for purchases’
- Invoice: A document giving a detailed description of goods or services bought or sold and their prices. Typically, an invoice will contain the names and addresses of the supplier and the customer, the tax or VAT number of the supplier, the date of the sale, a detailed description and price of the items sold and a total. Invoices are usually numbered.
A purchase invoice is a document received by a purchaser that provides evidence of goods or services bought. As previously stated, Karen’s accounting records should contain a purchase invoice or other document supporting each payment / purchase by her.
A sales invoice is a document given by Karen to a person who buys her work.
Most shops and supermarkets give small automatically generated checkout slips when they sell goods. These often are, in effect, invoices as they usually contain all the essential data. Karen should place them on her Payments file. If she feels that a checkout slip is not adequate in the case of a purchase, she should request a more detailed document. For instance, checkout slips seldom record the name of the purchaser. It is important that Karen’s business name appears on as many invoices as possible. Stores sometimes find requests for fully detailed invoices bothersome but they cannot reasonably refuse.
In everyday language, purchase invoices are often referred to as ‘bills’. Accountants prefer the more precise term, invoice.
– Receipt (1): A document stating how much cash has been received from a named person and the date it was received. When payment is made by cheque a receipt is not necessary, as the cheque is evidence of payment.
- Receipt (2): This term is also used by accountants to refer to money received in the course of business.
- Statement (of account): A summary list of invoices, taken from a supplier’s accounting records. Usually statements contain only the date and total amount of each invoice. A statement is not adequate evidence of a purchase. If Karen receives a statement from a supplier but does not have the invoices listed on it, she should immediately ask for copies.
-Bank Statement: A document issued regularly by a bank detailing transactions on an account with its customer. Bank statements are highly important core accounting records and should be kept carefully in date order.
So far we have:
- reviewed Karen’s bank accounts and explained why she should develop a good relationship with her bank;
- emphasised the importance of having a system for filing the paperwork associated with her finances;
- described a simple system for recording and analysing receipts (money in) and payments (money out) during the year;
- looked at issues to be considered when working with cash;
- pointed to the necessity of engaging an accountant and making an annual tax return on time.
We now turn to the preparation of financial budgets.
A budget is a financial plan for the future. It could relate to next week, next month, the next six months. Karen will usually find that a budget for a year in advance will be appropriate.
Like any plan, a budget seldom ends up precisely as initially hoped. A budget may be revised at any time. Some items may have cost more than expected, some less. A project may not have taken place; some unforeseen activity may start six months into the year in question. It is essential to have a financial plan. A plan provides focus and direction and will help Karen to maintain control of finances and the business as a whole. It ensures that, as far as possible, no major financial occurrence is overlooked.
Until her business has been running for a year, it may be a little difficult to draw up a realistic budget. However, towards the end of the first year, Karen should be in good position to plan for the next.
When preparing a budget, the starting point is to list all the categories of payments and receipts that relate to the business. Then place an annualised figure against each category. (An ‘annualised’ amount is a figure that relates to a twelve month period). Karen will find that the analysis of receipts and payments for the current year (see section on analysing receipts and payments) will be a helpful guide. Most budget figures will be estimates. However, they will be based on Karen’s personal experience of her business and her own future plans. Karen is the best placed person to prepare the budget. Budget figures should be realistic – that is, they should be a fair reflection of planned activities. It is unwise and foolish to insert figures merely because they serve to create the desired financial outcome.
The lines in a budget should be identical to those in the Receipts and Payments book A typical budget for an artist might be as follows:
|Income (Receipts)||Expenditure (Payments)*|
|Lecture fees||Rent of studio*|
|Awards||Books and Magazines|
|Other income||Training courses attended|
|Light and Heat*|
|Subscriptions to organisations|
for the year
for the year
* These figures should be an estimate of the business proportion of any expenses that also relate to Karen’s personal life.
(Note: Strictly speaking, there is a difference between the terms ‘Receipts and Payments’ and ‘Income and Expenditure’. Karen’s accountant will explain.)
For the business to be financially solvent, total estimated Expenditure must be greater than total estimated Income. This is because the budget refers only to Karen’s business, not her personal life.
The difference between the two amounts is, broadly speaking, Profit. Karen needs to make a Profit to meet her personal, non-business expenses. A Profit is equivalent to the pay Karen would earn if she were in an employed position. Profit also is used to develop the business: e.g. to buy new equipment, extend a studio, mount a one-person exhibition.
The article on Costing and Pricing your Work , also on this website, provides detailed advice about how to ensure that Profit comes in at the right level.
Once Karen has established a budget, she can use it as a reference point during the year to confirm whether she is achieving the planned outcome. She does this by comparing actual expenditure to date, as shown by the analysis of payments and receipts (see relevant section) with the figures in the budget. If things are not going to plan, some change of plan may be necessary. It is usually easier to identify a solution to a financial problem if the difficulty is faced at an early stage. To defer remedial action is seldom a good idea. Financial control is a key to running a successful and profitable business.
Click to view an example in outline format of a budget_report.
In conclusion, we return to the opening paragraphs of this article. Karen should regard herself in two distinct roles.
- Karen, the individual, who needs money to pay for her home, food, clothes, family, entertainment, holidays, and the like. She has to earn money to do this and has chosen to do so by running her own business.
- Karen, the business, who needs to create a profit sufficient to support her personal life and also to provide cash with which to grow the business.
Karen should find that this article and Costing and Pricing Your Work will help her to understand the financial fundamentals of running her business. She now would be well advised to book time with an accountant or accounting technician who will give her more detailed advice about putting into practice the principles set out in these articles.
By David McConnell
David McConnell is a consultant who provides corporate financial services to the arts sector – bookkeeping and accountancy services, in particular. He advises on grant applications and gives workshops. David is former chief financial officer to the Arts Council, Dublin. He also is an organist and choir director.