Know Your Numbers: Cash Flow, Taxes & Accounting for Interior Designers: Transcript

Do you love interior design but can't make the business side work? You've come to the right place. Welcome to Success by Design, mastering the business of interior design. Whether you want to elevate in your current interior design firm, start your own firm, or move the needle when it comes to your existing firm's trajectory, this is your masterclass and I'm your host, Katie Erickson.

Learn from my mistakes as I built a coast-to-coast multi-million dollar interior design firm. I share nearly 20 years of serving as a university professor of undergraduate and graduate business courses with you. And best of all, I bring in experts in all things business and interior design.

Class starts now. Hey friends, welcome back to Success by Design, the podcast where we talk all about building a business and a life that truly works for you. I'm your host, Katie Decker Erickson, and today we're digging into a topic that's foundational to running a successful design business or really any business for that matter.

We're talking about knowing your numbers. And before we dive in, let me make a quick disclaimer. Everything I'm sharing today is based on what I've found works in my business.

Full disclosure, as you probably know by now if you're a regular listener of the show, I am not a CPA or financial advisor, so always consult with a licensed professional to figure out what's best for you for your unique situation. Okay, now that we have all the legal stuff out of the way, let's get into why understanding your financials isn't just nice to have, it's non-negotiable if you want to build something sustainable. So, two truths and a lie.

I love doing two truths and a lie. Number one, you need to pay sales tax in states you've never even visited. Number two, having cash in the bank means your business is profitable.

And number three, if you ever want to sell your business, you better know your accrual from your cash basis accounting. Think you know which one is a lie? Well, stick around. Today, we're digging deep into why knowing your numbers is the only way to truly know your business.

So, here's the tough love moment. If you don't know your numbers, you don't actually know your business. You can be amazing at creating mood boards, developing floor plans, selecting finishes.

But if you're avoiding your P&L, or you have no idea how much cash is in the bank, you are flying blind. In fact, a 2022 study from US Bank found that 82% of business failures are due to poor cash flow management or poor understanding of cash flow. That's huge.

Let me give you an example. A designer I coached was regularly booked and busy. But when she finally looked at her books, she realized her profit was 30%, which is not sustainable.

All those client dinners, furniture advances, last-minute rush fees were eating into her profit margin, and she was letting her clients talk her into discounted rates. The revenue looked great when she started, but by the time it had all been chiseled away, her profit, well, not so much. So, we build systems.

Within three months, she had clarity, and she had cash reserves. What do I do in my firm as an active, practicing interior designer? Well, I meet with our accountant every single Monday. No exceptions.

It's a 30-minute standing meeting that often goes an hour, where we are going over all the things. Accounts payable, accounts receivable, and cash flow. You may be asking yourself, what is each one of these? Well, accounts payable is what we owe and when, and accounts receivable is what's owed to us and by whom.

And then finally, cash flow is what is coming in and what is going out and what is projected, because you have to know that to make good decisions as a CEO. The reality is this rhythm has been a game changer. It allows me to make decisions based on data, not gut instinct or panic.

For example, when we decided to bring on a PM or project manager, I can look at our rolling three-month cash flow and say, yes, we can support this hire responsibly. And as I always say, too, this isn't necessarily a full-time hire. This can be a contractor or a part-time hire as well.

Whatever position you're hiring and in whatever capacity, you've got to have data and finances to support it. So think of this like your car's dashboard before a road trip. You wouldn't hit the freeway, right, without gas or with the check engine light on.

This is exactly what your weekly check-in with your bookkeeper or accountant should be. Now let's talk about building a cushion. Most businesses are so worried about accounts payable, accounts receivable, and cash flow, they never get to this cushion part.

If you're already going timeout, I'm not even sure that I'm at the point where I can handle a cushion reserve or my profits aren't where they need to be, then let's have a call and a conversation about that as I would love to coach you through that. Meanwhile, let's talk about the cushion for those of you that are ready. I call it planning for a rainy day because in business, it's not if, it is when.

And at Colorworks, we keep three to six months of business expenses and reserves, and that is including our payroll, subscriptions, any overhead that we're carrying, everything we need to stay open and operational. And here's the kicker. That money isn't just sitting in our checking account.

We park it in a high yield account, whether this might be a high interest savings account, or right now I'm liking a really great money market account like Vanguard has an index called VMFXX, which we use, which at the time of this recording has been yielding about 5% annually. And we have access to our money whenever we want it, unlike CDs and other forms of investment that hold your money and don't let you get access to it. The reality is that's free money.

It's low risk. It's highly liquid, which means you have access to it. So it's there when we need it, like when a client payment is delayed, or we want to take advantage of a bulk purchasing opportunity.

Or in the case of tariffs lately, we've been beating a lot of those deadlines with orders that we need to get in, simply because we have the cash reserves to do so. And that's money in our pocket. And that's a change order we've avoided with our client.

And you better believe we let them know that we did this for them. It's a great marketing system to say we've got you and we're going to get this in before that price hike. Now let's talk about the how, because knowing your numbers isn't just about getting a report or two or three like I get on Monday mornings in my inbox.

It's about creating a system where those numbers are accurate, they're timely, and they're meaningful to you. So here's what we've implemented that I found extremely helpful, and I want to let you in on it. Purchase orders.

Every single item we procure goes through a purchase order system. And why do we need purchase orders? Well, it helps us track what we've committed to financially, even if we haven't been billed yet. Hugely important.

It also directly ties that cost to a specific project. So we know what our profit margin is at the end. You design with purpose, your flooring should too.

When you choose Shaw Contracts, EcoWorks Carpet, EcoWorks Resilient, or US Made Resilient Flooring, you're not just selecting high-performance materials, you're actively reducing landfill waste. With Shaw's Return Reclamation Program, return as little as 100 square yards of used flooring for free, and they'll recycle it into new products. Even flooring from competitors can be reclaimed, keeping more waste out of landfills.

Serious about sustainability? Specify smarter with Shaw Contract. Learn more at ShawContract.com. Another tool we use is CRM and invoicing software. And so we're tying our proposals directly to invoicing so nothing is slipping through the cracks, and the purchase orders are a big part of backing that up.

So I love QuickBooks. I also have an Excel spreadsheet, believe it or not, that has a great pivot table on it for our purchase orders so that our whole team can be inputting purchases and tying them to projects. There's other software out there, I'm not as big a fan of it.

Use an invoicing software so that you know exactly where your numbers are at. And then your monthly budget versus your actual reviews. So we are comparing what we plan to spend on a project versus what we actually spent.

We're also doing this every month with what we plan to spend on hours for our people versus what was actually spent. This keeps our team aligned and accountable. If a project went way over on hours or seems abundant in hours, we go back and review what happened.

Was that something we could have fixed on our side? Was that a change order from a client? Was there a subcontractor that ate up an inordinate amount of hours? Not only do we need to be able to answer those questions, but we need to have those answers for our clients in case they come to us as well, which is highly likely. Interestingly enough, one designer I work with thought she was losing money on every project, and it turns out she was losing a lot of money on every project because she wasn't tracking job-level profitability. Once we changed her software to allow for that, then she could scaffold out of that profitability margin she was looking for and adjust her pricing and scope accordingly.

A complete game changer, one that turned her entire firm from a jobby, as I like to call it, a job and a hobby, into a viable, sustainable, and scalable firm. So let's shift gears to something super important and often ignored in our industry. In fact, did you know CPAs, that's right, certified accountants, do not have to take a single course on sales tax? But oh, if you miss it, they will come find you and they will make you pay intense penalties.

Sales tax is so important to what we do in most states. Of course, there are states that do not have sales tax, but if you live in one of those and do business in a state that does, you are potentially not immune. Listening closely, because if you sell goods like furniture, art, or accessories, you are likely going to owe sales tax.

And depending on where your clients are, you may end up owing it in multiple states because of something called nexus. If that's a new term to you, don't worry, it was a new one to me, too, even as an MBA way back in the day. Now at Colorworks, we remit sales tax in numerous states.

And it took a while to figure it out because each one has their own set of rules. What is nexus? I'm glad you asked. It is basically a legal connection to a state.

So you create nexus if you store inventory or ship goods into a state, or if you have employees or contractors in that state, or if you hit a certain sales threshold, like $100,000. In most states, California and Texas are at $500,000. But once you hit that, you start owing sales tax to them.

And that is a one-time cumulative load. So if you say, well, I did $300,000 last year, but I didn't do it this year, guess what? The state of Texas does not care. You are close to hitting a $500,000.

And once you do, you better be prepared to remit sales tax in that state. The penalties for getting this wrong are so big. Oh, and I wish I could tell you that we haven't had to pay them.

When we first started out, we absolutely did. All it took, folks, was one time of having to pay that before we figured out real quick that we had to dial in our sales tax game. So again, talk to your CPA or a sales tax specialist.

There's software out there that can handle this for you, like Avalara and TaxJar. I just like having a real human to talk with and letting them sort the details for me and then implementing a system or a software like the ones I just mentioned. As I shared earlier, every Monday morning, I receive a financial snapshot of where we are at.

Before I check email, before I hop on my next Zoom call, I am looking at those three reports, accounts payable, accounts receivable, and the cash flow forecast. And literally, it is my version of checking the weather before I walk out the door. Just last month, we looked at trying a bunch of new software.

Because I had that Monday report in front of me, and because I was looking at our quarterly reports, I knew we could handle it this quarter. In fact, because of that, we are going to be launching a new website, cat's out of the bag, at Colorworks. Simply because we had the opportunity to do so and I could make that decision in good faith.

I also knew how much I wanted to spend on that new website design and that we could support that. And it was in keeping with what our numbers supported. We didn't have to touch reserves.

We didn't have to delay payments. We're already underway on design. And I don't feel scared to do it.

In fact, I feel excited. So the key, it is really about making your numbers routine and making them non-negotiable. I know it isn't the funnest part, but as soon as you do it, you're going to get back to doing what you really love with confidence because now you know you have the metrics to support your decisions that you're making in your business.

I'd like to finish out with something that separate businesses that grow and sell from those that stall. And here's the thing, accrual accounting. Most small businesses start out on cash basis accounting, and we did.

Absolutely. This means that your revenue or income is recognized when money actually comes in, and your expenses are recognized when money actually goes out. It seems simple, right? But it's not giving you the full picture.

And that is why we switched to accrual accounting. What this does is it recognizes income when it's earned and expenses when they're incurred, even if the cash hasn't moved yet. So if you're invoicing $50,000 today, you recognize it now, even if the client pays in 30 days.

Why does this matter? It's coming back to the common undercurrent of this episode. It allows you to see where your business is going. Also, if you ever go to sell your business, investors want to see accrual accounting as opposed to cash basis.

And it allows you to apply for financing if you want it, and you really want to go on a massive growth spurt with intentionality. All of these reasons require accrual accounting because it's showing the real health of your business. Now, you may say, I don't want to pay taxes this way, though, Katie.

And I would say, I agree, and you don't have to. You can still pay your taxes on a cash basis, which many of us do for tax efficiency. But our books overall are running on accrual.

In fact, it's a quick flip of a button, if you use QuickBooks, to switch between cash basis and accrual basis when it comes to looking at your numbers. There's more on the back end. But that allows you to look at what you need to on cash basis for tax remittance purposes.

So to wrap up, know your numbers like your life depends on it because, folks, your business life does. Meet with your accountant weekly, whether you want to or not. You go to the doctor.

The same is true of getting a wellness check for your business. Build a rainy day fund that earns interest while it waits. And I'm not talking about the 1% they offer at your local bank.

Find somewhere that's giving you 5%. Implement systems also that give you clarity, so you feel empowered to make decisions. Also, do not mess around with sales tax.

Understand your nexus for where you are geographically located, as well as where your contractors are located, as well as the places where your projects are located. Each one contributes to nexus. Don't be afraid to get a weekly financial report.

In fact, insist on it and make your decisions from that data point. And if you want to sell or scale your business, run your books on accrual accounting as opposed to cash basis. You may not be there yet, and that's totally fine.

Just put that away for a rainy day and know that if you ever want to sell, you need to be there. Now listen, I know this can feel overwhelming, but once you build the structure, the numbers start telling you the story of your business. And that's when you get to lead with confidence.

If you're ready to get a better handle on your numbers, or you just need help figuring out where to start, this is why I offer a free 15-minute call. We can talk about any of these concepts or whatever challenges you're facing in your business right now. And you can find the link to book that spot in the show notes of this episode.

All right, it's time for the moment you've been waiting for, the reveal of today's two truths and a lie. And hopefully by now, you'll be able to tease it out really quickly. As a refresher, here's your first one.

You need to pay sales tax in states you've never visited. Number two, having cash in the bank means your business is profitable. Number three, if you ever want to sell your business, you better know your accrual from your cash basis accounting.

All right, drum roll please. Truth number one, it is true. You can indeed owe sales tax in states you've never set foot in thanks to what we learned about today called Nexus.

If you're shipping goods, if you have remote team members or hit certain sales thresholds, you are likely on the hook. Another truth, number three, if you're thinking about selling your business one day, knowing accrual accounting is an optional, it's essential. Buyers and investors want clarity and accrual accounting delivers just that.

So what does that leave us with? Number two is our lie. Just because you have cash in the bank doesn't mean you are profitable. Cash flow and profit are not the same thing.

Profitability is about your income being consistently higher than your expenses and by a good margin. In fact, if you're wondering what that margin is, come talk to me. Now, if this surprised you, great.

Knowing the difference empowers you to make smarter, healthier business decisions. And I hope this episode gave you the clarity, the confidence and maybe even a little courage. So here's a sneak peek of what we're tackling next week as we dive deep into this series.

Have you ever felt guilty taking a break from your business even during a holiday? Well, in honor of the Fourth of July, we're going to explore how to confidently step away from your business without fear that it's going to fall apart. I'm going to share some practical tips for preparing your team, setting clear boundaries and embracing downtime guilt free because freedom in your business means freedom to truly rest as well. So we're going to see you next week for a special Independence Day episode on reclaiming your time and finding freedom outside of your business.

Until then, remember, your business should be working for you, not you working for it. Take care, talk soon and have a great week.