When it comes to growing your business, few decisions matter as much as tracking your company’s finances. In the beginning, many small business owners try to manage their books independently rather than using an in-house accountant or bookkeeper.
For many business owners, going it alone leads to easily avoidable mistakes. Here’s a look at some of the biggest accounting mistakes that can derail small businesses, along with some tips for avoiding them.
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The biggest accounting errors small businesses make
What often seems like a minor accounting error can have significant consequences for your business’s finances. Here are some examples of common accounting errors.
- Overstating cash flow: Adequate cash flow is a crucial aspect of running a successful business. Unfortunately, many businesses overestimate how much cash they have on hand. Overstating your cash flow can make it hard to manage cash flow, pay your employees and vendors, and fund important business purchases.
- Incorrectly tracking income: If you don’t accurately track your business’s revenue, you could end up over-reporting or under-reporting your income. This can have tax consequences down the road.
- Incorrectly tracking expenses: Another common mistake businesses make is failing to track some of their expenses. This will increase your taxable income and cause you to pay more in taxes at the end of the year.
- Forgetting to pay invoices: When vendors send invoices for services rendered, they likely have a due date within 30 to 60 days. If you don’t stay on top of your accounting, it’s easy to overlook these due dates and pay your invoices late. This can lead to late fees and damage your relationship with your vendors.
- Missing the signs of fraud: Some business owners want to handle all the accounting themselves, while others make the mistake of outsourcing everything. You should never put yourself in a position where you don’t know what’s going on with your business finances. Failing to track your finances could cause you to miss the signs of fraud.
Tip: To prevent employee fraud, vet your team thoroughly during the hiring process and minimize employees’ access to financial information.
7 accounting mistakes to watch out for
Here are some common accounting mistakes business owners make, as well as some tips on how to avoid them.
1. Failing to hire an experienced finance professional
Even experienced accountants and bookkeepers make mistakes, but they’re finance professionals, and you probably aren’t. Even if you are, is it really worth the extra time investment to manage your business’s books on your own? Hiring a professional will minimize the potential for errors in areas like expense tracking, paying vendors on a timely basis, balancing bank accounts, and running payroll.
Are you confident you’re handling employees’ tax withholdings properly? Are you keeping track of all your financial transactions, regardless of size? Just a few mistakes in these areas can cost you more than you’re saving by not hiring a professional.
You’re best served by considering hiring a bookkeeper licensed by the National Association of Certified Public Bookkeepers. They mainly record your business’s financial transactions, typically using the best accounting software.
Certified public accountants assist with tax planning and help you spot trends – and avoid mistakes – as you’re managing your books. To verify that a potential hire is a CPA, check their license in the AICPA database.
If you can’t afford a full-time, in-house financial professional, another option is to hire a freelance bookkeeper or accountant who works remotely. This route is relatively easy, thanks to the wide selection of sites that match employers with professional freelancers.
For instance, businesses that tap into FINSYNC’s virtual assistance network have access to skilled financial professionals.
Tip: To hire the right accountant for your business, check for accountants who follow a fiduciary standard and are required to put their client’s best interests above their own.
2. Not tracking business costs accurately
If you’re not keeping accurate records, your accounting and bookkeeping become much less effective. When that happens, you leave your business vulnerable to losing money and being late on important bills. This sets you up for major headaches come tax season and more problems that can get in the way of a growing business.
It’s not just errors made when entering transaction data into a spreadsheet or failing to note that you paid a bill. Inaccurate financial tracking ultimately costs your business money and undermines your ability to plan for the next month or beyond.
It’s essential that your accounting system – whether it’s just you and a spreadsheet or a bookkeeper – keeps track of every transaction so you can accurately gauge the financial health of your business.
While it helps to have a financial professional handle your books, there is another opportunity to help you or your bookkeeper do their job better: an integrated accounting system.
Accounting software keeps track of all of your financial transactions. Every time you pay bills, deposit or withdraw money, or send an invoice, your accounting software will keep a record automatically.
3. Mixing personal finances with business accounts
Small business owners often blur the line between their personal and business finances. It’s understandable, especially when a business is just beginning to find its footing.
You go to Costco or Walmart to pick up some office supplies and, because you’re already there, get a few items for your home.
But it goes beyond combining business and personal items on a single receipt. More than one-quarter of small business owners don’t have a separate bank account for their business, according to a survey by Clutch. That’s not a good move. Using one account can make it tougher to sort out your personal and business transactions, which could cause significant issues when tax time comes around. With sloppy financial accounting, you may even miss an expense that you could list as a business deduction.
Blurred lines between business and personal accounts could also be a problem when you apply for a loan or line of credit, as lenders want a complete and accurate snapshot of your business’s finances when they consider your loan application.
If you’ve been using your business and personal bank accounts interchangeably, break that habit. Open a separate business bank account. You’ll likely get some incentives to do so from the bank where you have your personal account.
If you’re shopping and in a bind, always separate business and personal purchases so you can set aside business receipts.
Tip: If you’re using a personal credit card for business purchases, apply for a business credit card. Major banks like JPMorgan Chase have cards that cater to small business owners and offer cashback bonuses on purchases.
4. Inefficiently managing billing
Cash flow is essential to keeping a business operating from one day to the next. Billing or invoicing customers efficiently goes a long way toward ensuring that your revenue comes in promptly so you can tap into it for expenses, payroll, and other needs.
Sometimes, businesses that don’t have a good handle on the accounting end of their operations can fall well short of sufficient cash flow. Invoicing gets delayed, and customers take longer to pay, leaving your business stretched thin to cover its bills.
Being late paying your bills isn’t the only ramification of inefficient bill management. Some 82% of U.S. businesses fail because of cash flow problems, according to Visual Capitalist. Another 29% fail because they run out of cash altogether.
To tune up your billing management, begin by invoicing your customers immediately after you’ve fulfilled your end of the transaction.
Emailing an invoice is better than sending a bill by snail mail. For a quicker, more seamless process for collecting unpaid invoices, there’s also software that can send invoices to your customers automatically.
5. Not properly planning for tax season
Do-it-yourself tax software may be suitable for preparing a simple tax return, so it can be an attractive solution for small businesses looking to save money on an accountant or other tax specialist.
If you’re tackling your business tax filing using the DIY approach, you may stumble if you haven’t taken steps along the way to document your company’s finances properly.
No one enjoys piecing together a year’s worth of receipts and documents in April because they were disorganized the other 11 months of the year. That goes double for businesses, which must navigate a more complicated route to comply with Uncle Sam’s increasingly complex tax laws.
In the Clutch survey, while more than 93% of small businesses said they are very or somewhat confident in their ability to file their taxes accurately, nearly one-third also said they believe they end up paying too much come tax time.
Everyone gets complacent about receipts and records now and again. The best approach is to minimize errors and oversights by ensuring that your business uses an accounting system that seamlessly tracks company expenses, payroll, and other fundamental components of your business’s profit and loss statement.
Bottom line: Enlisting a qualified tax professional to check in periodically and do tax-related organizing sweeps of your business can help you spot potential savings and things your business could be doing differently well before the tax year is over.
6. Failing to classify employees properly
Small businesses rely on employees, freelancers, independent contractors, and gig economy workers to get the job done. How they classify these individuals could result in lawsuits and tax penalties if they do it wrong.
If a small business owner misclassifies an employee, it means federal and state governments miss out on payroll taxes, and the penalties for that could be substantial, according to the U.S. Department of Labor.
Business owners may be on the hook to cover payroll, Social Security, unemployment, and Medicare taxes for employees it misclassifies. The business can also get hit with penalties and face lawsuits if employees aren’t reimbursed and provided benefits under the Fair Labor Standards Act.
To avoid misclassifying employees, you must determine if they are employees or contractors based on the jobs they perform, how they are paid, and their relationship with your company.
If the employee works eight hours a day, five days a week, is paid a salary, and receives health benefits, they are a full-time employee. If the person works and gets paid per project and isn’t provided any benefits, they should probably be classified as a contractor.
Once you’ve made that determination, make sure the worker fills out the correct documentation based on their classification. A contractor fills out a W-9 form while a full-time employee completes a W-4 form.
If you make a mistake but can prove to the IRS that you have a “reasonable basis claim,” you can get relief. You need to prove one of the following to be eligible:
- You reasonably relied on a tax-related court case or ruling by the IRS to make your classification determination.
- Your business was audited by the IRS when the employees in question were treated similarly to independent contractors, and the IRS didn’t reclassify the workers.
- You treated your workers as independent contractors because the rest of the industry does so, and you can prove that.
- You relied on the advice of a lawyer or accountant who knows about your business.
7. Going paperless without a backup
The last thing a small business owner wants to go through is a tax audit. But if you do have to, the more paperwork you have, the better off you’ll be.
In this digital age where everything lives in the cloud or on an app, it’s understandable that people don’t save their paperwork for a few weeks, let alone seven years, but the IRS will want it during an audit.
A good rule of thumb is to save the following documents for at least seven years:
- Business tax returns
- Payroll tax records
- Current employee information
- Business ownership records
- Accountant records
- Records from operations
Tucker Mathis and Donna Fuscaldo contributed to the writing and research in this article.