Accounting is one of the most important aspects of any enterprise, but it’s still surprising how many small business owners are completely unaware of basic accounting principles. If you’re a small to medium business owner who handles most of the accounting in your business on your own, or have your have your accounting done by an accounting department or a third party, there are some crucial mistakes that you need to steer away from if you don’t want to face severe consequences. In this article, we’re going to touch on five of the most common mistakes business owners make when it comes to accounting.
Not Taking Taxes Into Account
If you don’t collect the right amount or make the payments on time, the IRS and any lower level tax agency can put your business under severe penalties. Make mistakes like not collecting taxes on taxable items or failing to send the money on to the revenue office, and you could see your personal property seized or you could even be sent to jail.
Your business needs to take taxes into account in several ways. If you sell a taxable product or service, you must ensure that you charge the right amount of sales tax and pay it to the relevant authorities on the dates required. This is in addition to paying federal income taxes, Social Security taxes, FICA and other tax payments that should be paid at least monthly. It is a sure sign that a business will fail when it raids the tax withholding from its employees’ paychecks to pay their other bills.
If in doubt, consult with a CPA to know how much tax you’ll need to collect and when you need to pay it to the government.
Failing to Set Aside Retained Earnings
“Retained earnings” is the term for a business’ emergency fund. Too many small businesses look at the money left over in the bank account at the end of the month as something to spend on their next “want to have” bullet list item and don’t set aside savings within the business.
You need to have savings in the name of the business for several reasons. First and foremost is training yourself and/or your team to spend according to a budget barring the occasional unplanned expense. Getting in the habit of spending all the cash you have on hand leads to having a constantly tight financial margin and increases the risk you’ll need to borrow against future earnings to pay for unexpected expenses.
Another reason to set aside retained earnings in a business savings account is to give you margin in case sales or profits are lower than your baseline expenses one month. It is easier to control the spending impulse and save part of the takings on a good month and use it to cover expenses on a slow month than adding people during booms only to lay them off when business is slow.
Not Using Formal Purchase Orders and Receipts
There are several reasons to use formal purchase orders for products you buy and printed receipts or invoices when you sell items. Using formal purchase orders that you track in your accounting software application helps prevent someone using a handwritten purchase order to steal from the company. You don’t have to go through a lot of work to create one; you can find a free printable purchase order template online. Printing and tracking orders via a free printable purchase order template also helps you avoid duplicate orders. Issuing receipts and purchase orders makes book keeping easier by ensuring you don’t duplicate transactions, and it makes audits much simpler. Depending on your industry, they may actually be required by the auditors.
Mixing Personal and Business Accounting
One of the biggest mistakes small business owners make is mixing personal and business accounting. They borrow on personal credit cards to finance the business but lack the expertise to write off the correct amount as business debt payments as they make credit card payments. They buy personal items through the business; this can be interpreted as tax fraud if you write off personal expenses as business expenses, and using the business as a personal account raided whenever your family needs money pierces the corporate veil that prevents personal assets from being forfeit if your business is sued, too.
There’s a less dramatic reason to set up separate business accounts as soon as you start the business. It makes record keeping for the business much simpler, as well as audits if they occur. You can use personal funds to start the business, but it should be listed as a loan that is repaid to you personally at a later point.
Don’t use the business account to pay personal expenses. Withdraw money as a salary to pay your living expenses. Life will be simpler if you pay yourself a set amount or percentage of revenue and it makes it easier to calculate your personal income taxes at the end of the year, too.
Not Understanding Cash Flow Versus Profit
Cash flow refers to the amount of money coming in each month. However, it isn’t what you make that matters, it is what you keep. What you keep after expenses like payroll, inventory purchases and taxes is your profit. Too many small businesses brag about their high cash flow but fail to track how much profit they earn per month. And it is the amount of profit cleared each month and profit as a percentage of cash flow that is used by others to rate the success of the business.
You don’t have to track your profit for each product sold or store location at first, but if you don’t know that the item you sell at $100 costs you $200 after labor and other costs are factored in, you’ll go out of business as soon as you can’t borrow to cover the losses each month.
How can you avoid accounting mistakes that can sink your business or hurt you personally? Keep a close accounting of your profits relative to income and expenses, collect the relevant taxes and pay them on time, and engage a professional when necessary, don’t mix personal and professional income and expenses, use formal purchase orders and receipts for literal accountability with your staff, customers and tax authorities, and save some of your profits to pay the bills when income drops.