Most small business owners aren't accountants by trade. But whether their background is in product development, HR, management or anything else, they have to learn the nuts and bolts of accounting.
The good news is that small business accounting is relatively simple. Companies that operate in a single state and have a simple business structure have three accounting priorities:
- Ensure their revenues exceed expenses
- Keep their books clean
- Pay their taxes
Still, small business accounting can be tricky for leaders without any sort of financial background. Use these 11 accounting tips to stay on the right path.
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1. Keep business and personal accounts separate.
One of the messiest accounting blunders small business leaders can make is to mix their business and personal funds. Although plenty of entrepreneurs chip in their own startup money, business revenue and expenses must be separate from personal ones.
The best solution is to start with a sound business structure. Establish your company as a distinct legal entity, such as an S corporation or LLC. Open a business checking account as your financial hub, and pay yourself a salary from it each month. Get a business credit card for expenses you can't or don't want to pay cash for, and open a business savings account as a rainy day or investment fund. Track any business usage of your personal items.
2. Classify workers properly.
When it comes time to build a team, you have two choices: employees and contractors. The IRS considers employees to be those you have behavioral authority and financial control over, as well as a long-term business relationship with. Contractors, meanwhile, are people who work for your company on a project basis and retain control over their own schedules and business decisions.
The penalties for misclassifying workers are steep. On top of the $50 for each W-2 form that the employer of misclassified contractors must pay, the employer pays fees of 1.5% of wages and 40% of FICA taxes that it didn't withhold from the employee. The employer must also pay 100% of the FICA taxes that it would've paid per employee. If the IRS believes the misclassification was intentional, the employer could be fined up to $1,000 per worker or imprisoned for a year.
3. Calculate total labor costs before you hire.
If you decide to hire employees, know that you'll be on the hook for more than just their wages. At least once a month, you'll have to come up with the funds for their benefits and payroll taxes. Those costs add up faster than many small business owners realize. According to an OnPay survey, just 43% of those who do payroll themselves are confident in their ability to pay their employees on time. The rest are either behind on their books or too eager to expand their team.
Don't put yourself in the position of having to cut compensation post-hire. Even if you were generous with your initial wages and benefits, your workers will feel cheated if you pare them down. Small businesses can't afford high turnover, especially among their first few hires.
4. Create profit and loss statements regularly.
A profit and loss statement is a staple accounting tool that summarizes your company's income and expenses over a given period. All public companies are required to put them out once per quarter. Although small business owners aren't required to create them by law, P&L statements are great ways to see whether you're on track to meet your financial goals.
Follow these steps to generate a P&L statement:
- Total up the revenue you generated in the quarter.
- Itemize your company's expenses. Sort those expenses into two categories: operating expenses and cost of goods sold (COGS).
- Subtract the total expenses from your gross profit to get your operating profit.
- Subtract interest and taxes from that operating profit, and you'll know whether your business operated at a profit or a loss that quarter.
Although individual P&L statements are valuable, quarter-by-quarter comparisons are even more important. Are your operating expenses growing? Is your profit shrinking, despite your sales figures going up? Checking P&L statements against one another yields those sorts of insights. [Looking for software to maintain your books? Check out our guide to the best accounting software.]
5. Always get a receipt.
You can claim a good chunk of your company's expenses as tax deductions. Bookkeeping service Bench lists 16 categories in which expenses are fully or partially deductible. These expenses include meals with clients, ad campaigns and office rent. In order to claim them, though, you need receipts for tracking and verification purposes.
Donations are one area where small business owners often forget to get a receipt. Although companies of certain structures, such as LLCs and partnerships, can't claim contributions to charities as business expenses, the owner often can. Ask recipients of in-kind donations for written confirmation of the time spent, and use documentation to defend the fair market value of any property donations you make.
6. Keep a close eye on accounts receivable.
Although staying on top of accounts payable is important, they don't dictate the company's survival like accounts receivables do. If there isn't money coming in the door, then the company can't continue to operate. Each month, review the percentage and total amount of outstanding revenue. Generally speaking, no more than 10% to 15% of your accounts receivable should be past due. Reach out weekly to those clients. Don't send them to collections on a whim, especially if you want to work with them in the future. But you also can't let them stiff you.
One solution is to institute penalties for late payment. Set a monthly finance charge of 1% or 2% of the principal. If you decide to charge 2% on an initial charge of $5,000, for example, you'd add $100 to the invoice every month that it isn't paid. Be sure to tell clients this in advance: Not only is this legally important, but the threat of penalties is often enough to dissuade poor payment practices in the first place.
7. Invoice accurately and regularly.
Invoicing is a necessary part of owning a business, but it can feel cumbersome and time-consuming. Plus, if you make mistakes, it can hurt your ability to get paid. That's why it's extremely important to ensure you send out accurate and regular invoices.
The invoices should be detailed, laying out specific information about the transactions, and you should send them in a timely manner. You should also follow up with email and/or text reminders to increase your likelihood of getting paid. By keeping detailed and accurate records of your invoices, you can spot customers who fail to pay on time and reward those who are always early.
8. Stay on top of tax deadlines.
As an individual, you pay taxes once per year. Most small businesses, however, have to file estimated quarterly tax payments. Quarterly payments are made on two types of taxes: self-employment tax (which includes Social Security and Medicare taxes) and income tax on the profits your company makes.
Follow these steps to decide whether you need to pay quarterly taxes:
- Subtract your federal income tax withholding from the amount of federal taxes you expect to owe this year. If that figure is less than $1,000, you don't need to make quarterly payments.
- Take the total federal tax you expect to owe this year and multiply it by 0.9. If you've withheld at least that much, there's no need to make quarterly payments.
- Compare your total federal income tax on last year's return to your withholding amount. If it's at least as much, you don't need to pay those quarterly taxes.
If you do need to make estimated tax payments, here's when the next four are due:
- First quarter: April 15
- Second quarter: June 15
- Third quarter: Sept. 15
- Fourth quarter: Jan. 15, 2022
9. Set (and stick to) your own payment terms.
Big companies commonly pay on net-60 or even net-90 terms, meaning that they actually transfer funds either two or three months after receiving an invoice. Your small business can manage its cash flow by operating the same way. The key is consistency. Say you pay on net-30 terms. Make clear at the time of service that your vendors can expect you to pay in 30 days. Don't pay early, or the vendor will expect the same next time; don't pay late, or they may not want to work with you in the future.
10. Bring in the experts instead of DIY accounting.
Business owners like to control all aspects of their business, but sometimes it pays to outsource processes and functions – like accounting and bookkeeping – to the experts. By hiring a professional, you can reduce accounting mistakes and ensure that your accounting records are accurate and up to date. It will also save you a lot of time. A CPA can review your books to help you identify ways to cut costs and boost spending in growth areas.
11. Use accounting software.
Accounting software was once cost-prohibitive for many small businesses, but now you can access robust accounting software for a monthly fee (or even free). Accounting software is increasingly easy to use and provides small business owners with a ton of features and services, including ones for sales tracking, budgeting, inventory management, financial statements, payroll and taxes.
In addition to automating processes and accurately tracking and balancing your books, cloud-based accounting software can often integrate with many of the other business software programs you use. Sharing data across applications can reduce errors and save you the time it would take to manually input data into your accounting software. [Read more information in our Sage accounting software review.]
Accounting may not be the sexiest part of being a small business owner, but it's an essential one. Mistakes in your books will come back to bite you. Tax troubles will only get worse, and you may miss a tax deadline. If you're in over your head, call an accountant. There's no shame in asking for help. [Read related article: What to Do if You're Behind on Your Taxes]
Donna Fuscaldo contributed to the writing and research in this article.