Are you guilty of making any of these accounting mistakes? You're not the only one. Here's how to fix your process before it affects your business.
Accounting mistakes can impede the growth of your small business and put it on shaky ground. Unfortunately, mistakes are all too common, especially for new or quickly growing businesses.
In this article, we’re sharing five of the most common accounting mistakes small business owners make – and some tips for avoiding making these bad-for-business bloopers yourself.
Mistake #1: Not Staying on Top of Receivables
Entrepreneurs have a variety of reasons for going into business for themselves, but one thing they all have in common is a goal to make a profit. If you want to make money in your business, you need to get paid, and that means you need to keep track of what clients owe you.
When you issue an invoice, it creates a receivable – that’s how much the client owes you. Checking your Accounts Aging report will show which customers have an outstanding balance and how old the balance is. As soon as you receive payment from a customer, you should apply that payment to the receivable to mark the invoice as paid.
There are two accounting mistakes small business owners make when it comes to receivables. First, if they prepare invoices manually rather than using accounting software, it can be challenging to know which clients owe you money and which payments are late. Those are major sources’ of cash flow problems for many small businesses. When clients regularly take 60 days or more to pay invoices, you may find yourself short on cash even when revenues are good.
Another accounting mistake small business owners make is procrastinating on reconciling customer payments. With an already overloaded to-do list, putting off reconciling payments to accounts receivable may seem like a minor issue. The problem is, at the end of the year you have a bunch of deposits in your bank account and a list of receivables that doesn’t make sense.
You’ll end up wasting hours updating your Accounts Aging report. You might even overpay on your taxes if you wind up recording the same revenue item twice.
Make sure you have procedures in place to track your receivables, follow up on invoices when they come due, and reconcile payments to outstanding receivables. It will save you time and money in the long run.
Mistake #2: Not Keeping Receipts for Expenses
Many small business owners fail to save copies of receipts for business expenses, assuming that a bank statement or credit card statement is enough documentation for accounting and tax purposes. However, this can lead to a series of problems.
First, how many times have you looked at your bank or credit card statement and had no idea what that $100 charge is? Maybe you purchased supplies, bought dinner for a client or accidentally used your business credit card for a personal expense.
Without a receipt providing details about the charge, you may incorrectly categorize transactions. Plus, you’re in for a much bigger problem if the IRS selects your tax return for an audit.
IRS auditors may request supporting documentation for any business deduction claimed on your tax return. For the deduction to hold up, you’ll need to present proof of the following information:
- The expense amount
- Where and when it was made
- The business purpose of the expense
If the deduction relates to a business meal, the IRS may require even more information. They’ll want to know who was at the meal and what business issues you discussed. You certainly won’t find that on a bank statement and without it, the auditor can deny your deduction, assess additional tax, interest and penalties.
To avoid this headache, save a receipt for every business purchase. Keep an envelope in your purse, laptop bag or car to save your receipts instead of losing them in your wallet or purse. Every week or month, go through those receipts and ensure you’ve logged the expense in your business books.
You can then keep the original receipt in a folder or scan them and store a copy digitally. Better yet, take advantage of cloud accounting software that lets you take a photo of your receipts on the go.
Mistake #3: Mixing Business with Personal
Many businesses, especially solopreneurs, make the mistake of using their personal checking account or credit card for both business and personal expenses. While the IRS doesn’t require that you maintain separate bank accounts, they do encourage it.
Comingling funds can cause several accounting, tax and legal problems. First, when you use one account for both business and personal expenses, trying to sort out income and deductions takes a lot of time. You have to worry about this every quarter when it’s time to make estimated tax payments and at year-end when it’s time to prepare your tax return.
Plus, depending on your business structure, you may have a legal requirement to keep everything separate. For example, if you have an LLC or a corporation, your personal assets are protected by a “corporate veil.”
Comingling funds could allow creditors to “pierce the corporate veil” and access your personal assets in the event of a lawsuit or cause you to become personally liable for the corporation’s debts.
Set up dedicated checking, savings and credit card accounts for your business and use them only for business-related expenses. If you transfer money from your business checking account to your personal account—or vice versa—document the reason. You, your accountant and your attorney will sleep easier at night if you maintain a strong separation from the start.
Mistake #4: Trying to DIY Your Tax Return
Small business owners often try to save money by preparing their own tax return. But, not hiring a professional can cost big bucks down the road. You may not be aware of all of the deductions for which you qualify, or you might underpay your tax bill—leading to penalties and other fees.
Spending the money to hire a tax professional means you’ll have access to an expert who knows what they’re doing and can apply the right tax strategies to your situation. Qualified tax pros spend a large portion of every year keeping up to date on ever-changing last laws and can help you plan ahead to reduce your tax bill for years to come.
When you hire a tax professional, look for someone available year-round. Some tax professionals set up shop from January through April, then disappear the rest of the year. That makes it difficult for you to get help if you receive an IRS notice or have a tax question between May and December.
Mistake #5: Working with an Accountant Who Doesn’t Speak Your Language
Have you ever sat down with your accountant and had a conversation about depreciation, working capital, cost of goods sold, GAAP, passive activity losses and the potential benefits of electing Subchapter S status? If you understood all of those terms, you must have aced your college accounting courses. Other small business owners might nod along, but leave the accountant’s office more confused than when they entered it.
Most small business owners aren’t accounting and finance experts and don’t have the time or inclination to stay up to date on the latest accounting jargon and tax strategies. That’s your accountant’s job, and translating all of that technical talk into language you can understand should be part of the package.
If your accountant is dropping buzzwords and lingo that leaves your head spinning, tell them. Ask them to give it to you in plain language. If they can’t, you might not be working with the right professional.
Accounting isn’t most business owner’s strong suit, but that doesn’t mean you can neglect your books or turn it over to someone else and stop paying attention. This puts you at risk of cash flow problems, embezzlement or worse.
Invest in cloud accounting software that gives you real-time visibility into your business’s financials and work with your accountant or tax pro to get a basic understanding of your company’s income, expenses and tax situation.
If any of the above accounting mistakes are already impacting your business, it’s not too late to make changes that will help you generate better financial results down the road.
This is an optimized post and was originally published on the FreshBooks blog in October 2013.
about the author
Janet Berry-Johnson is a CPA and a freelance writer with a background in accounting and insurance. Her writing has appeared in , , , , and . Janet lives in Arizona with her husband and son and their rescue dog, Dexter. Outside of work and family time, she enjoys cooking, reading historical fiction and binge-watching Real Housewives.