As a small business owner, there are many bookkeeping mistakes you cannot afford to make. Mistakes made by the business owner usually lead to a setback in your operations. More significant errors can have you overpay taxes, fines, and penalties. A huge enough mistake could even put you out of business. Here are the most common bookkeeping mistakes made by business owners and some tips on how to avoid them:
Co-mingling of personal and business funds
Co-mingling of funds means storing money intended for different purposes in the same bank account. Co-mingling of funds is a common practice used by new small business owners. Still, there are several reasons why the co-mingling of funds should be avoided at all costs:
- According to the IRS, only businesses can deduct business expenses. Please consult IRS Publications 525 and 535 for specific guidelines for determining whether an entity is a business or a hobby.
- Tax time becomes a nightmare if funds are co-mingled. It is very time-consuming to separate personal and business transactions during tax filing.
- Separate business funds will provide a clear audit trail.
- Co-mingling of personal and business funds can lead to missed deductions.
- Co-mingling can show a lack of professionalism. Writing a check using your name instead of your business signals that you are not a serious business venture.
Take the time to open a small business banking account to simplify your record-keeping and life.
Failing to classify employees correctly
Due to the gig industry, there are so many independent contractors, consultants, and freelancers around these days. It can sometimes be challenging to determine who is on staff and who is not. DO NOT ignore this issue, however. Misclassifying employees and contractors can have serious consequences, such as tax penalties and lawsuits. Please consult IRS Publication 15-A for further details.
Failing to collect or deduct the appropriate sales tax
The growth in e-commerce has made sales tax more complicated for many small businesses. Historically, the most common sales tax mistake was failing to deduct sales tax from total sales, translating into lump-sum surprises come tax time. While that still holds true, recent federal law changes related to the court case South Dakota v. Wayfair have made sales tax collection more complicated when it comes to online, state-to-state fulfillment. Make sure you and your bookkeeper are familiar with the latest laws about sales tax and its compliance issues so that you can limit your overall tax liability.
Failing to track reimbursable expenses
If you do not track your expenses, you are flushing money down the toilet. Not only can you lose money, but you can also lose tax deductions, which is yet additional money down the road. Make it a habit of tracking your expenses as you accrue them; otherwise, you may overlook some of your expenses. Hubdoc, ReceiptBank, and Receipt Capture are the most popular expense-tracking apps and allow you to scan, store, and organize your receipts and documents.
Bookkeeping without using reputable accounting software
Quite often, many new business owners use a spreadsheet for bookkeeping. Although spreadsheets can work for a simple bookkeeping system, it does not support growth for your company. There are many benefits to using accounting software. You can track all aspects of financial management, such as inventory management, payroll, invoicing, and expense management, in one central location. You can also generate reports related to cash flow, balance sheet, and profit and loss. All these reports show the financial health of the business. Your financial statements are always ready when filing taxes or applying for bank loans by maintaining your financial records in the software.
Neglecting to reconcile accounts
Reconciling your books with your bank statements is one of the most crucial tasks during monthly bookkeeping. It helps you understand how much money is coming in and going out. It also allows you to discover bank errors before they become huge problems. Reconciliation can be complicated, however, which is why hiring an experienced bookkeeper is highly recommended. Accounts that should be reconciled monthly include (but are not limited to): bank accounts, credit cards, loans, and lines of credit.
Wasting more time than you need to
If your bookkeeping system isn’t tailored for your business, you’ll spend way more time doing the books than you should. Thankfully, this situation can be easily avoided. Setting up a customized chart of accounts (COA) from day one is key. The chart of accounts is the foundation of the bookkeeping system.
If you don’t know how to do this yourself, an accountant or bookkeeper can:
- Customize your chart of accounts for your business
- Enter your initial balances
- Teach you how to classify your expenses properly before you start doing your own books
- Give you a “bookkeeping” checklist for you to tackle periodically (weekly or monthly)
Not reviewing your financial statements
Financial statements are a direct window into your business’s financial performance. If you don’t review them regularly (or you don’t know how to review them at all), you’re missing out on some big-time opportunities to generate revenue and avoid financial disaster.
Financial statements can help you:
- Stay in control of your cash flow
- Create and stick to a budget
- Spot ways to maximize your tax deductions for the year
- Successfully apply for a bank loan
- See financial trends in your business
- Know when to spend, and when to save
- Make smart financial decisions that help your business grow
- Show potential investors how your business is performing
Not sure how to find any of the above in your financials? Learn how to read financial statements and ask your CPA for guidance. You’ll be armed with better financial insights, and your business will benefit in the long run.
Recording payments to yourself as an expense
We’re getting into the nitty gritty here, but we see this bookkeeping mistake quite often. Sole proprietors and single-member LLCs: when you pay yourself, don’t categorize the payments as an expense. It’s an easy mistake to make. But it will lower your overall profit, and display a false total for the income you need to pay tax on. Instead, record these payments to an equity account called “Owner’s Draw.”
Trying to do it yourself
Most small business owners do not enjoy doing their books yet do their bookkeeping during the first few years. If the business owner does not have the skill or the experience for bookkeeping, usually he will end up with messy books that are not up to date. When the books are not clean or caught up, tax season can be very painful for the business owner. Cleanup and catching up of books can be costly. It is better to hire a professional bookkeeper who has the required skills and the experience to do the job quickly and efficiently. They will be able to locate subtle errors that might otherwise be missed and be aware of the tax changes that could affect your day-to-day financial practices.