Independent Contractor vs Employee

As companies get started, they often delay hiring employees and instead use independent contractors. After all, once a contractor becomes an employee, the Company is now responsible for payroll taxes: federal income tax withholding; Social Security and Medicare (together, Federal Insurance Contributions Act (FICA)); and Federal Unemployment, not to mention new liabilities under the Patient Protection and Affordable Care Act (PPACA). Here are the general guidelines from the IRS:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)?

If you answer no to the questions above, you’re likely fine keeping the individual as an independent contractor. However, I recommend speaking with your accountant to get specific advice.

How does a company with significant revenue, run out of cash?

A few years ago I met with a new client who had raised several rounds of funding and had significant revenue (if you were looking at from an accrual method of accounting perspective). When I asked what the bank balance was, I realized we had a problem. In fact, it was going to be difficult for them to even make payroll the next month.

You see, the company was selling goods to its customers with credit cards but not collecting the cash from the credit card companies for months later. You can’t make payroll today with cash you will receive in three months even if the revenue is earned today.

Accrual accounting recognizes transactions when they occur regardless of when the cash is exchanged. Cash accounting, on the other hand, recognizes transactions only when there is an exchange of cash.
As your company is getting up and running it’s critical to look at your books from a cash flow perspective.