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In the United States, anyone can start a new business. One of the first steps is choosing the best type of business entity for the company you’re starting. Let’s take a look at the types of business entities and the business entity definitions.

💡 Recommended: How To Incorporate in 6 Steps

Sole Proprietorships

A sole proprietorship is the simplest type of business entity. Creating one requires little or no paperwork, and it isn’t a corporation. The owner is the business.

Definition and Characteristics

A sole proprietorship is an unincorporated business in which the owner is the only employee. There’s no need to register with the state, but to operate in certain industries, you may have to obtain a business license or permit. If you’d prefer not to do business under your legal name, you can create an alias known as a DBA, which stands for “Doing Business As.”

The advantages of a sole proprietorship are its simplicity and the low cost of creating it. Handling taxes is straightforward: You report the business’s profits on your personal tax return using Schedule C. The disadvantage is that you are personally responsible for any business losses, since there’s no legal separation between your individual and business finances.

Partnerships

A partnership will have multiple owners. This type of business entity has two kinds of legal structure: general partnerships and limited partnerships.

General Partnerships

A general partnership is basically a sole proprietorship with two or more owners. As with a sole proprietorship, you won’t need to file any paperwork with the state. But you will want to draw up a partnership agreement among the owners. The agreement should specify how the business partners will divide any profits or losses, which will be reported on the partners’ personal tax returns. General partnerships also do not shield participants from personal liability.

Limited Partnerships (LPs)

A limited partnership, or LP, requires registration with the state. This type of partnership specifies which people will operate the business and assume liability — called general partners — and which ones will act only as investors. The investors are known as limited partners or silent partners. If additional capital is needed, general partners can raise it via small business loans.

An LP structure makes it easy for general partners to run the business and raise money from limited partners, who aren’t liable for debts beyond their initial investment. If a limited partner decides to leave, the business can continue. Profits are shared based on the terms of the partnership agreement, which should include how and when profits are distributed.

For tax purposes, LPs are considered “pass-through” or “flow-through” entities. This means that the enterprise’s taxes are paid by the individual partners via their personal income tax returns, rather than separately by the partnership.

Another type of limited partnership is a limited liability partnership, or LLP. This is a type of partnership often used by professional services companies, such as law firms or dental practices. It shields each partner from extensive personal liability in cases of, say, malpractice. LLPs involve written partnership agreements and must typically file annual reports in most jurisdictions.

Recommended: Sole Proprietorships vs LLC: How to Choose

Corporations

Corporate types of business entities have more complicated legal structures. The two main types are C corporations and S corporations. The IRS automatically considers all corporations to be C corporations. To secure S corporation status, owners must take additional steps.

C Corporations

C corporations are owned by shareholders, operated by management, and overseen by a board of directors. As a business entity that’s legally separate from its shareholders, a C corporation files its own tax returns and pays income taxes at the corporate rate. Shareholders pay taxes on their share of the profits when they file their personal tax returns. This so-called “double taxation” is a disadvantage of C corporations.

S Corporations

A C corporation can become an S corporation — or “S corp,” as it’s commonly known — by filing IRS Form 2553 and meeting certain IRS eligibility requirements. S corps provide some tax advantages to their owners. In most states, the shareholders can pass the business’s profits and some losses through to their personal income taxes.

Like C corps, S corps still need to create bylaws and hold board meetings and shareholder meetings. But unlike C corps, S corps are limited to 100 shareholders and can issue only one class of stock.

You may have heard of B corporations. That’s not actually a type of business entity. Instead, B corp status is a certification issued by a third party. It’s meant to recognize a company’s commitment to public transparency and the highest standards of verified social and environmental performance.

Close corporations, also known as closely-held corporations, are typically smaller companies. They have less formal corporate governance and cannot publicly trade shares. A close corporation could be operated by a small group of shareholders without a board of directors.

Limited Liability Company (LLC)

A limited liability company, or LLC, has some features of unincorporated sole proprietorships and partnership, as well as elements of more formal S corps and C corps. Like a corporation, an LLC is a separate business entity that limits the liability of an individual. But LLCs require less paperwork, as you don’t need to have shareholders or a board of directors. As for taxes, owners of an LLC can choose to have the income taxed directly (as with a C corp) or pass it through to their personal tax filings.

Forming an LLC is more expensive than creating a sole proprietorship or partnership. The cost of creating an LLC can range between $35 and $300. And while some states don’t charge an annual fee to renew an LLC, most do; California’s annual $800 fee is the highest.

An LLC can have one member or multiple members. For a multi-member LLC, you need to create an operating agreement that sets out the rules and structure for the business.

Licensed professionals such as doctors and lawyers have the option of creating a professional limited liability corporation, or PLLC. The specific criteria vary by state.

Recommended: What Are the Tax Benefits of a LLC?

Factors to Consider When Choosing a Business Entity

Given the many types of business entities, it’s important to carefully choose the one that best suits your needs. For people who are just starting a business on their own, a sole proprietorship offers a speedy, simple and low-cost solution that enables them to begin doing business immediately. There are few tax implications, but also no liability protections.

It’s easy to convert a sole proprietorship into a partnership as your business grows, if that’s what you choose. That way, even with more than one owner, the company retains all of the advantages of a sole proprietorship.

For other businesses, creating an LLC will make more sense. Choosing LLC status offers you a way to quickly register your business, and it allows for the eventual hiring of employees. An LLC’s key advantage over a sole proprietorship or a partnership is the owner’s limited exposure to liability and loss.

A C corp can be a wise choice for businesses that anticipate substantial growth. It requires the creation of a board of directors; protects the owners from personal liability; and allows you to sell shares, making it easier to raise funds. However, profit from a C corp is subject to corporate taxes in addition to personal taxes paid by the shareholders. If your company qualifies as an S corp, you can escape this double taxation.

The Takeaway

The various types of business entities come with different advantages, costs, levels of complexity, and tax challenges. Not all of them will be suitable for your new business. As you consider your options, research their financial, legal, and recordkeeping details to ensure you choose the one that makes the most sense for your business needs.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

Photo credit: iStock/visualspace

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

SOSMB-Q424-046

Business owners require capital to start and grow their companies — and occasionally they need that funding right away. To close a gap in cash flow or jump on a fleeting business opportunity, some owners will take out same-day business loans. Let’s take a closer look at what the varieties of same-day loans are, what they require, and how to get one.

What Are Same-Day Business Loans?

Same-day business loans are those that are approved and available within 24 hours, as the name suggests. This is a much shorter turnaround time than most types of business loans. Some lenders have streamlined their approval processes for same-day loans to require less-extensive paperwork.

Types of Same-Day Business Loans

Short-term loans, lines of credit, merchant cash advances, and invoice financing are all commonly used for same-day business funding.* The terms and conditions tend to differ from those of regular small business loans. The details of these four same-day options will help you identify which kind of instant business loan best meets your needs.

Short-Term Loans

Term loans require the borrower to make regular, fixed payments on a set schedule. Short-term business loans often call for repayment within 12 months or less, though some may last up to 24 months. A short-term business loan may or may not require collateral.

Business Lines of Credit

A business line of credit, like a credit card, enables the borrower to spend the available funds at any time. Repayment terms are flexible: A business can take money out, repay it, and borrow again, as often as necessary.

Merchant Cash Advances

A merchant cash advance is a type of short-term loan. The lender advances a lump sum to a business, with repayment conditions based on a percentage of future sales. This type of loan can be funded quickly, but be aware that its interest rate can be significantly higher than other forms of financing.

Invoice Financing

This arrangement enables a business to borrow money against invoices — that is, against the outstanding balances due from its customers. Typically invoice financing is meant to help a business with its cash flow while it pays its employees and suppliers. One type of invoice financing, known as invoice factoring, involves selling your unpaid invoices to a third party that collects its money from each bill when it’s paid.

Who Qualifies for Same-Day Business Loans?

Requirements for same-day business loans will vary by lender. Most will have a minimum credit score that could be as low as 500, but is often 600 or higher. Some lenders that offer same-day business funding may want to look at several months of bank statements, while others may also consider a business’s outstanding invoices.

💡 Recommended: Improving Business Cash Flow

Advantages of Same-Day Business Loans

The primary attraction of instant business loans is their speed. When a lucrative deal presents itself, quick access to capital may allow a business to place orders right away and start meeting demand for its goods and services.

Another advantage of same-day business loans is the lack of paperwork. While a long-term business loan could take weeks or months of preparation, you can often apply for a same-day loan in minutes.

A same-day business loan can also offer flexibility, in that your company is permitted to use it for any purpose. In contrast, many long-term business loans are only approved for specific uses.

Potential Drawbacks

Same-day business loans have drawbacks as well. For example, same-day business loans often have higher interest rates and fees, to account for the lender’s increased risk of loss. A same-day loan will also have shorter repayment terms. And if a business uses multiple short-term loans — potentially to pay off existing ones — it risks getting caught in a debt cycle that can be difficult to resolve.

How to Apply for a Same-Day Business Loan

Applying for a same-day business loan can be quick, but you’ll still need to take some time to prepare your application. You’ll want to select the right type of loan for your needs, and then shop around to find the best combination of rates, terms, and fees that you can qualify for.

Then you’ll need to gather the required documentation. This can include your bank statements, profit and loss statements, and even your outstanding invoices.

But once you’ve filled out the application and provided the required documentation, you should get a decision within hours.

Alternative Financing Options for Businesses

It’s easy to apply for instant business loans, but there are other possible sources of short-term capital to bear in mind as well.

A small business credit card lets you access funds and gives you a secure, convenient repayment method. Small business credit cards are approved based on the applicant’s personal credit history and other qualifications, meaning that the primary cardholder is always responsible for repayment. Some small business credit cards will offer up to a year of interest-free financing on new purchases, and nearly all cards will offer a grace period in which interest can be avoided if the statement balance is paid in full.

For longer-term financing at lower interest rates, traditional bank loans are also available to small businesses. In particular, business owners may want to approach the U.S. Small Business Association (SBA). The SBA backs small business loans that are provided by designated lenders who approve and manage their loans. It facilitates 7(a) bank loans for various business purposes.

Your company may qualify for 504 loans, fixed-rate financing for major assets provided by community-based, nonprofit SBA Certified Development Companies regulated by SBA. The agency also arranges microloans of $50,000 or less for businesses and certain childcare centers.

Best Practices for Using Same-Day Business Loans

Because same-day business loans can be easy to obtain, it’s crucial that business owners keep in mind a few best practices for handling that money.

First, it makes sense to only get a loan for the amount you actually need. Overborrowing will lead to higher payments over the life of the loan, forcing you to spend money your business may need elsewhere.

Once you have the loan, it’s important to make your payments promptly. Short-term loans typically have high interest rates and fees that can be extremely costly if you miss a payment.

The best way to avoid late fees and other penalties is to set up automatic payments. Autopay helps you increase the amount of your monthly payments to the maximum you can afford. Making larger payments will enable you to pay off the loan sooner, thereby saving money on interest charges.

If you find yourself unable to pay off the same-day loan early, you may want to add some long-term financing. Long-term business loans at lower interest rates can save you money if you use the principal to pay off your higher-interest short-term loans.

The Impact of Same-Day Loans on Business Credit

As with any lender, your same-day loan provider is likely to supply balance and payment information to the major consumer and small business credit bureaus. During the repayment phase of your same-day loan, owing a large amount may temporarily lower your business’s credit score. When you make timely payments on your loans, though, it’s likely to help your business credit rating. Successfully paying off your debt will add positive information to your business credit report.

The Takeaway

Same-day small business loans often help companies meet urgent business needs in the short term. If you’re considering one, start by calculating how much debt your business can afford to take on. Then figure out which instant business loans might work best for your company by comparing the lenders’ rates, terms, fees, and turnaround time.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

Photo credit: iStock/wutwhanfoto

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

Small Business Loans
*Reference to “same day funding” or “funding within 24 hours” describes a general capability of many lenders you can reach through SoFi’s marketplace. Funding or funding timing is not guaranteed. Your experience with any lender will vary based on requirements of the lender and the loan you apply for. To determine the timing of funds availability, you must inquire directly with any lender. In addition, your access to any funds from a loan may be dependent on your bank's ability to clear a transfer and make funds available.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

SOSMB-Q424-045

When you’re starting a business, you may opt to structure it as a sole proprietorship. A sole proprietorship is one of the simplest and easiest business entities to establish, which is why many consultants, contractors, and entrepreneurs decide to go this route.

What Is a Sole Proprietorship?

A sole proprietorship is a business run by just one person, as its name implies. Here, we take a look at this type of business entity to give you a clear picture of its pluses and minuses.

Definition and Basic Characteristics

A sole proprietorship is an unincorporated business that’s owned and operated by one individual.

If you’re the only member of a domestic limited liability company (LLC) and choose to treat it as a corporation — as many business owners do for tax purposes — the IRS does not consider you a sole proprietor.

Legal Status of Sole Proprietorships

Anyone who starts doing business without incorporating is considered a sole proprietor. Legally there is no separation between you and your business, so the company’s debts and assets are treated as your personal debts and assets.

In some states, sole proprietors in certain industries must apply for various business licenses or permits. You may also be required to register a name for your business.

Advantages of Sole Proprietorship

Sole proprietorships are popular for several reasons. First, it’s easy to set one up. Depending on your state, you may have a minimal amount of paperwork that’s easy to complete online, or you may not have to file anything at all. Also, being a sole proprietor gives you complete control of your company. There are no employees or supervisors to manage; it’s just you.

Finally, there’s the flexibility. You can convert your sole proprietorship into another type of business entity, such as an LLC or an S corporation, at any time. You can do this later as you acquire employees or find that your business needs have changed.

Disadvantages of Sole Proprietorship

Sole proprietorships have their downsides as well. As mentioned above, a sole proprietorship treats your business assets as personal assets, meaning you’re individually liable for any company losses. If your business were to lose a lawsuit, you yourself would be responsible for any damages. Getting small business loans can be more difficult for sole proprietors, as banks can consider these businesses to have a higher risk.

Furthermore, sole proprietors may find that having a one-person business can complicate their work-life balance. When your business is run by you and you alone, it may seem like you’re always at work.

Operating as a sole proprietorship also limits the business’s lifespan. When you retire, the business will cease to exist. You will be able to sell off the business’s assets, but not the business as a whole.

Sole Proprietorship vs. Other Business Structures

When planning your new business, also consider alternatives to a sole proprietorship. Each will have its pros and cons.

Limited Liability Company (LLC)

An LLC structure can protect owners’ personal assets from bankruptcy or lawsuits, unlike a sole proprietorship. Getting a business loan for an LLC is easier than getting one for a sole proprietorship. However, setting up and maintaining an LLC costs more, due to state fees and annual reports, and taxation rates and rules may differ.

Partnerships

If more than one person will own the new business, it’s automatically a general partnership (unless the owners opt to make it an LLC). Establishing and running a partnership is simple, but as with a sole proprietorship, owners have no financial protections; they are personally responsible for any losses or damages incurred by the business. An LLC can be equivalent to a partnership for tax purposes.

Corporations

A standard corporation — often called a C corporation — is its own entity, legally separate from its owners. This means that the corporation, not its owners, are held legally liable for damages. There are also tax considerations. The corporation pays tax on its profits, while its owners and employees also pay taxes on their earnings. An S corp is a distinct type of corporation that, like a sole proprietorship, avoids this type of double taxation.

Recommended: Sole Proprietorship vs LLC: How to Choose

Who Should Consider a Sole Proprietorship?

A sole proprietorship can be ideal for a small business owner without employees who wants to get a company up and running quickly. This structure can work well for small business owners who have very little exposure to legal liability. Examples would include freelance writers, artists or online product resellers.

Setting Up a Sole Proprietorship

With little or no paperwork involved, anyone can start a sole proprietorship in minutes and start charging for their products or services. Bookkeeping is often simple, with billing based on standard “Net 30” invoices.

Depending on your field and the state you’re doing business in, there may be no legal requirements at all to operate as a sole proprietor. Nevertheless, for certain industries — such as barbers, electricians, plumbers, and architects — you may be obligated to register or get a business license.

With a sole proprietorship, you can use your own legal name as the name of your business. You may wish to file DBA (“Doing Business As”) paperwork to register your business name. Depending on which state you’re in, this step may not be necessary, but it does help you establish a separate identity for your business.

For example, instead of operating a roofing business as just “Bob Smith,” you could call your company “The Roofing Guy,” “Tri-State Roofing,” or any other name that’s available.

Tax Implications for Sole Proprietors

Sole proprietors’ income is subject to pass-through taxation. This means that the business owner reports business income or losses on their personal tax return. With their annual IRS Form 1040, they must file a Schedule C, as well as a Schedule SE for self-employment tax used in calculating Social Security benefits.

In addition, each quarter sole proprietors must pay estimated taxes using Form 1040-ES.

Recommended: What Are the Tax Benefits of a Limited Liability Company (LLC)?

Growing and Evolving Beyond Sole Proprietorship

If your business outgrows its sole proprietorship status, you can easily convert it to another type of business. All you need to do is to file the appropriate documents for an LLC, partnership, or corporation. Nothing else is needed to dissolve the sole proprietorship.

You may also wish to file an IRS Form SS-4 to obtain an employer identification number (EIN). Like a Social Security number (SSN), an EIN is a nine-digit number that businesses use to identify themselves to the IRS for tax filing and reporting purposes. You may also use an EIN when applying for a small business credit card or for other banking purposes.

The Takeaway

A sole proprietorship is the easiest type of business to create. This type of business has both advantages and drawbacks, including tax and liability considerations. Understanding how a sole proprietorship differs from partnerships and various corporate entities will help you choose the best structure for your small business needs.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

How do I register a sole proprietorship?

If you’re operating your sole proprietorship under your legal name, no registration is required. Otherwise, you may wish to register a DBA (“Doing Business As”) name. Depending on the nature of your business, your state may also require that you obtain a license.

Can a sole proprietorship have employees?

No. In a sole proprietorship, the owner is the company’s only employee. But a sole proprietor may hire independent contractors as needed.

What happens to a sole proprietorship when the owner dies?

When a sole proprietor dies, the business ceases to operate. The business’s assets and liabilities become part of the owner’s estate.

Photo credit: iStock/Rockaa

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOSMB-Q424-018

Retained Earnings are the profits a business has accumulated that are not distributed as dividends to shareholders but instead are reserved for reinvestment back into the business. These funds can be used for a variety of purposes, including working capital, purchasing fixed assets, and paying off debt.

Retained earnings are an important part of any business because they provide the means to reinvest in and grow your business. Companies with healthy earnings will often try to achieve a balance between rewarding owners/shareholders while also financing business growth.

Read on to learn why retained earnings are important for every business, how to calculate retained earnings, and how these funds can be used.

💡 Recommended: What Is Net Income?

What Are Retained Earnings?

By definition, retained earnings are the cumulative net earnings or profits of a company after accounting for dividend payments. In other words, retained earnings are the profit that a business generates after costs such as salaries or production have been accounted for, and once any dividends have been paid out to owners or shareholders.

Retained earnings are reported on a company’s balance sheet under owner’s/shareholder’s equity, which is a measure of what a business is worth. Retained earnings value can fluctuate from quarter to quarter and year to year depending on whether they are accumulating or being used.

If you run a very small business, you might not even account for retained earnings and simply consider them part of working capital. However, it can be worth generating a separate statement of retained earnings. This can be a key financial statement to have on hand, especially if you’re going to apply for a small business loan. Potential investors may also be interested in looking at your retained earnings.

💡 Recommended: Accounts Receivable Financing

Calculating Retained Earnings

In small business accounting, the retained earnings formula starts with the beginning-of-period retained earnings amount. That is carried over from the prior period’s retained earnings figure. Net income (or net loss), located at the bottom of the income statement, is then added to the first figure. Dividends, both the cash and stock types, must be removed to arrive at the end-of-period retained earnings amount.

Here is the retained earnings formula:

RE = Beginning Period RE + Net Income/Loss – Cash Dividends – Stock Dividends

At the end of each accounting period, retained earnings are reported on the shareholder’s equity section of the balance sheet. In the next accounting cycle, the retained earnings ending balance from the previous accounting period will now become the retained earnings beginning balance.

It’s possible for this balance to be negative. This could happen if the current period’s net loss is greater than the retained earnings beginning balance, or if a distribution of dividends exceeds the retained earnings balance.

Any factors that impact net income (such as changes in sales revenue, cost of goods sold, depreciation, and other operating expenses) will directly affect the retained earnings balance.

Recommended: How to Calculate Cash Flow

How Do You Use Retained Earnings?

Retained earnings can be used for a variety of purposes. Here’s a look at some of the options.

Paying Off Debt

Many businesses get their funding through different types of small business loans. Ultimately, those obligations must be paid back, and retained earnings are often used to do that. Repaying debt early can also save on interest costs, boosting profits and future retained earnings. (Keep in mind, however, that some lenders may charge a prepayment penalty.)

Mergers and Acquisitions

Retained earnings can also be used to grow a business by funding a merger, business acquisition, or partnership that could open up the company to new opportunities.

Growth and Expansion

Retained earnings may be reinvested into the company in order to:

•  Launch a new product/variant

•  Increase production capacity of the existing products

•  Hire more staff

•  Buy new equipment and machines

•  Invest in research and development

This reinvestment into the company aims to achieve even more earnings in the future.

Share Buybacks

If a company’s owner or management does not believe it can earn a sufficient return on investment from its retained earnings, it might conduct share buybacks. This involves paying shareholders the market value per share and reabsorbing that portion of the company’s ownership.

Pros and Cons of Retained Earnings

Retained earnings have both advantages and disadvantages. Here’s a look at how they stack up.

Pros of Retained Earnings

•  They are an inexpensive source of funds, since (unlike loans) there are no interest payments or fees.

•  There are no conditions on how you can spend the money.

•  They can increase your future retained earnings if reinvested wisely.

•  They can be used to repay high-interest loans, as well as short-term debt to reduce accounts payable.

Cons of Retained Earnings

•  The amount of retained earnings rises and falls depending on profit trends and dividend payouts.

•  If shareholders believe you are not using the money effectively, they may feel cheated out of dividend income.

•  Owners and managers may decide to spend the funds simply because the money is there and potentially waste it.

•  High retained earnings could cause owners/managers to make risky investments.

Recommended: What Is Accounts Receivable Financing?

Are Retained Earnings a Debit or Credit?

The normal balance in the retained earnings account is a credit. This number indicates that a company has, over its lifetime, generated a profit. However, the amount of the retained earnings balance could be relatively low even for a financially healthy company, since dividends are paid out from this account. Consequently, the amount of the credit balance does not necessarily indicate the relative success of a business.

When the balance in the retained earnings account is negative, this indicates that a business has incurred losses. This can happen during the startup years of a business, when it may incur sustained losses before it has accumulated enough customers and released enough products to bring in a reasonable profit.

Retained Earnings vs Dividends vs Revenue

Retained earnings, dividends, and revenue are all important ways to measure a company’s financial health. Each, however, looks at a different component of a company’s finances.

Dividends, whether distributed in the form of cash or stock, reduce retained earnings. If a company is focused on growth, it might not pay dividends or pay very small dividends and instead use the retained earnings to invest in new equipment, research and development, marketing, and/or acquisitions to boost growth. If this is the case, the company will have high retained earnings.

A more mature company, on the other hand, may not have many options for investing surplus cash and might prefer to pay dividends. In this case, a company will have low retained earnings.

Revenue refers to the total earnings a company generates through its core operations before removing any expenses.

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The Takeaway

Retained earnings are the amount of net income a company has accumulated over time after it has paid out dividends to its shareholders. There are a number of ways a business can use retained earnings. When a company is focused on growth, it may choose to use all or most of the retained earnings to fund expansion activities. Businesses in later stages might opt to use the money to pay additional dividends.

Retained earnings can also be used to determine whether a business is truly profitable. Lenders, creditors, and investors will often look at a company’s retained earnings, along with its revenue, to gain insights into the firm’s financial performance and potential for growth.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

What are some examples of retained earnings?

Retained earnings are the amount of net income a company has left after it has paid dividends to owners/shareholders. It’s calculated by adding net income to retained earnings at the beginning of the account period, then subtracting dividends.

For example, if a company starts the accounting period with $20,000 of retained earnings, then brings in $30,000 in net income and pays out $15,000 in dividends, this would be the calculation:

$20,000 + $30,000 – $15,000 = $35,000

In this example, the company has retained earnings of $35,000 for this accounting period.

How are retained earnings calculated?

The formula for calculating retained earnings is as follows:

Retained Earnings (RE) = Beginning Period RE + Net Income/Loss – Dividends Paid

Are retained earnings assets or liabilities?

Neither. Though retained earnings can be used to purchase assets, they are not considered a business asset. Retained earnings are reported on the balance sheet under the owner’s/shareholder’s equity section at the end of each accounting period.

Photo credit: iStock/Valerii Evlakhov

SoFi's marketplace is owned and operated by SoFi Lending Corp.
Advertising Disclosures: The preliminary options presented on this site are from lenders and providers that pay SoFi compensation for marketing their products and services. This affects whether a product or service is presented on this site. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider. See SoFi Lending Corp. licensing information below.

This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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Business insurance keeps your business protected from the unexpected, whether that’s a lawsuit or a natural disaster. It also limits the liability you have for contingencies, such as someone slipping and falling on your business property. But, different types of business insurance protect your company in different ways.

Keep reading to learn more on how business insurance can protect your company, different types of business insurance, how to choose the right business insurance for your business, and how to pay for business insurance.

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What Is Business Insurance?

While there are different types of business insurance, they all generally do one thing: protect your company. Paying a monthly or yearly premium for insurance can provide you with peace of mind, knowing that if your business property should experience loss or damage, those expenses will be covered by your insurance policy.

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6 Types of Business Insurance for Companies to Consider

While there are many types of business insurance, we’re going to take an in-depth look at the following six types:

•  Workers’ compensation

•  Liability insurance

•  Commercial vehicle insurance

•  Property insurance

•  Errors and omissions

•  Data breach insurance

1. Workers’ Compensation

If you have employees, you may be required to have workers’ compensation coverage. If you have an employee who is injured in a work-related accident, this policy will cover medical expenses, rehab and retraining costs, and disability payments while your injured employee isn’t at work.

Depending on how many workers you employ, workers’ compensation coverage is required in every state except Texas. Check your state’s requirements for more details.

Costs also vary depending on your payroll and state, but as a point of reference, many businesses spend an average of $540 annually.

Pros and Cons of Workers’ Compensation

The main pro of having workers’ compensation coverage is that you won’t have to pay out of pocket for on-the-job injuries. And if your business is in a physically active industry, such as manufacturing, the risk for these types of injuries may be high.

The major drawback applies to businesses that aren’t in physically demanding industries, because they’ll likely still be required to carry it for each employee, and this can add to payroll costs.

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2. Liability Insurance

The next kind of insurance to consider is liability. There are several types of liability insurance, including workers’ compensation. Two other types of liability insurance include:

•  General liability insurance: General liability insurance, also called public liability insurance, protects you in the event of someone being injured on your commercial property. If a customer fell and broke her hand in your store, your general liability insurance would cover any legal fees if she sued you, as well as her medical expenses. The average cost of general liability coverage is about $500 a year for small businesses.

•  Product liability coverage: If you sell products, you might want to consider product liability coverage, which will protect you from paying out of pocket for any legal fees related to issues with your product, such as defects or malfunctions. Product liability may be included in general liability coverage. Bought separately, if you break out the cost, the rule of thumb is $0.25 per every $100 of product sales.

Pros and Cons of Liability Insurance

Some companies require their vendors to have liability insurance. If you work with companies that do (or want to), having liability coverage can ensure you have more business opportunities.

On the other side of the equation, costs for liability coverage can vary widely depending on the kind of coverage you’re seeking, how long you’ve been in business, your industry, and other factors. That can make it difficult to budget for the insurance ahead of time.

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3. Commercial Vehicle Insurance

If you use a vehicle for your business, you’re required to have commercial vehicle insurance, just the way you need to have auto insurance for your personal car or truck. This will cover not only you, but also any employees you have who will drive the company vehicles.

It’s important to note that having a personal car insurance policy will not cover your commercial vehicles.

While the costs for commercial vehicle insurance vary depending on your coverage and how many vehicles you need to insure, for a policy limit of $1 million, the average cost is about $1,700 a year.

Pros and Cons of Commercial Vehicle Insurance

If you have commercial vehicles, commercial vehicle insurance is required. The main benefit is having peace of mind should you or an employee get into an accident. You’ll have coverage for medical expenses incurred from the accident, as well as for repair costs for the vehicle.

The main drawback is the expense. And if you or an employee does get into an accident, your premium could rise, cutting even deeper into your profits.

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4. Property Insurance

Whether you run a business located in commercial real estate or out of your home, having property or business rental insurance can cover damages to your property or loss of your property. This may include damage or loss caused by theft or natural disasters (but note that earthquake or flood coverage typically needs to be purchased as a separate policy).

Even if you run your business out of your home, you may want to consider property insurance, possibly through a homeowner’s policy. Expect to pay around $800 a year for commercial property insurance.

Pros and Cons of Property Insurance

What would happen if your office caught fire and you lost all of your computer equipment? Without insurance, you would be stuck paying to replace the equipment. Property insurance means that, should the worst happen, you probably won’t have to go into debt to get back up and running after a disaster.

The drawback is that property insurance doesn’t cover everything. If, for example, an employee trips and drops his laptop and breaks it, this may not be covered. And if you live in areas prone to earthquakes, you may not be able to file a claim for earthquake damages with a standard policy.

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5. Errors and Omissions Insurance

If you’re in certain industries, like medicine, consulting, real estate, or law, one of the types of business insurance you may be required to carry is errors and omissions (E&O) insurance, also called professional liability insurance.

This coverage can protect you in the event that you’re sued for malpractice, even if you weren’t negligent. Here’s an example: Let’s say you’re a project management consultant and your client misinterpreted the project plan, and as a result incurred extra costs and delayed the project. The client sues you for those costs, but with E&O coverage, those costs would be covered.

Costs may vary, but some policies can be found for under $800 a year.

Pros and Cons of Errors and Omissions

The major benefit of E&O insurance is protecting yourself. If a client or patient sues you, having E&O coverage will help ensure that you don’t go broke trying to cover legal expenses.

On the other hand, it can be confusing to know what you’re getting with an errors and omissions policy. That’s why it’s imperative to read your policy documents carefully to make sure you understand exactly what’s covered.

6. Data Breach Insurance

How much thought have you given to data breaches at your company? You may assume that only large corporations suffer from problems like these, but in fact, 43% of data breaches happen in small businesses. If you store sensitive data on the cloud or on any kind of electronic device, this might be a type of insurance to consider.

Data breach insurance (or cyber insurance, which may be a little more inclusive and expensive) may lower your risk of experiencing a breach by offering credit card monitoring services. If you experience a breach, some insurance policies will send a notification to your customers to alert them, cover costs to find the cause of the data breach, pay for a public relations consultant to restore your reputation, and/or cover legal costs if you’re sued as a result of the breach.

Policies can vary quite a bit in what services they provide and what they pay for, so it’s important to read the fine print of any insurance policy you’re contemplating buying.

Cyber insurance costs average $1,740 a year.

Pros and Cons of Data Breach Insurance

Recovering from a data breach could take months, if not years, and many companies have suffered from negative reputations as a result. Should you be the victim of a breach, you need to ensure that things can go back to business as usual as soon as possible, and data breach insurance can help you get there.

The downside of data breach insurance is that your company might never experience a breach, and you might feel like the investment is wasted money. But then again, the purpose of insurance is to cover an accidental and to provide reassurance that if it happens, you’re going to be okay.

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How to Pay for Business Insurance

Paying for business insurance can be managed through various methods depending on your financial situation and business needs. Here are some options:

•  Business savings: Using funds from your company’s savings is a straightforward way to pay for insurance premiums. This avoids debt but requires careful cash flow management.

•  Small business loan: Many small business loans allow you to use funds for operational expenses like insurance. This helps cover costs upfront but requires repayment with interest.

•  Credit card: Some businesses use credit cards for short-term payment of insurance premiums. While convenient, it can be costly due to high interest rates if balances aren’t paid off quickly.

•  Payment plans: Some insurance providers offer monthly or quarterly payment plans. This spreads the cost over time, making premiums more manageable for businesses with tighter cash flow.

•  Revenue from sales: Using revenue from day-to-day operations can cover insurance premiums, ensuring you’re funding insurance from your business’s ongoing earnings.

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The Takeaway

Six major types of business insurance include workers’ compensation, liability insurance, commercial vehicle insurance, property insurance, errors and omissions insurance, and data breach insurance. Start with the policies that you’re required to have for your business, then consider whether you might need any of the others as protection against a worst-case scenario.

You can pay for your insurance policy with funds from the company or external financing, such as credit cards or a small business loan.

If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.

FAQ

Is business insurance tax-deductible?

Yes, business insurance is typically tax-deductible as an ordinary and necessary business expense. Premiums for coverage like liability, property, and workers’ compensation insurance can often be deducted, reducing taxable income. Always consult a tax professional for guidance.

Can I change my business insurance coverage as my company grows?

Yes, you can adjust your business insurance coverage as your company grows. Expanding operations, hiring employees, or acquiring assets may require updates to policies like liability, property, or workers’ compensation to ensure adequate protection. Regular reviews with your insurer ensure coverage aligns with your evolving business needs.

What happens if a business operates without insurance?

Operating without business insurance exposes a company to significant financial and legal risks. Uninsured businesses must pay out-of-pocket for damages, lawsuits, or accidents, which can result in severe financial strain or bankruptcy. Additionally, it may violate legal or contractual obligations, leading to fines, penalties, or lost business opportunities.

How often should I review my business insurance policies?

You should review your business insurance policies annually or whenever significant changes occur in your business, such as growth, new employees, or added services. Regular reviews ensure your coverage remains adequate and aligns with evolving risks, helping protect your business from potential liabilities and financial losses.

Photo credit: iStock/courtneyk

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This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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