It's easy when you run a small business to focus on the day-to-day needs of your business. Things like servicing your customers, buying merchandise, marketing and trying to make things run as smoothly as possible take center stage.
But in so doing, you may tend to forget that a part of every business is "the business end" of the business – what might commonly be called, "keeping the books."
While we tend to use the term bookkeeping, many small businesses don't really do "bookkeeping." They simply do their best to keep track of the financial things as they know them in a lot of different ways. Perhaps they use their checkbook or have a notebook to record transactions. Maybe they rely upon a cash register or use a spreadsheet. They may even try to use a product like QuickBooks or some other accounting software.
The problem is two-fold. First, they didn't go into business to do bookkeeping, at least not if they are not in the bookkeeping business. Second, they didn't learn, and they don't really want to learn, any more about bookkeeping then they have to.
As a result, many small businesses go through a period of trial and error when it comes to keeping their finances properly documented. Unfortunately, their errors may not only come back to haunt them, but actually bite them on their butts if they are not careful.
Some of the most grievous bookkeeping blunders a small business can make include:
Combining Personal and Business Funds
Co-mingling - smaller
Many small businesses get their start with funding from personal cash outlays and the use of home office equipment. They often fall into a pattern of co-mingling of business and personal when it comes to bank accounts, income, expenses and assets.
A sole-proprietor should use a separate bank account for their business and also obtain a business credit card. They should post only business transactions in these accounts. When purchasing assets, it's necessary to make certain to identify what percentage, if any, is used for "personal" as opposed to 100 percent business.
Small business corporations must keep all aspects of their business separate from their shareholders personal finances. This means only using the company bank account and credit cards for the company’s business. Never use any personal bank accounts or credit cards for business matters. Company owners should be paid a regular wage or salary just like any other employee of the corporation. Cash advances to a business from personal funds should be recorded as capital contributions or loans.
Failing to keep personal and business finances separate can be a serious and expensive tax issue. A trusted advisor should be able to advise a small business on the proper segregation of its business and personal finances to ensure the accuracy of its financial statements for tax purposes.
Not Performing Bank Reconciliations
One of the most fundamental aspects of bookkeeping is reconciling the books and bank statements every month. Reconciling is the procedure whereby the transactions in the bank account or on a credit card statement are matched to the bookkeeping ledgers of the accounting system.
Reconciliation is an essential step in verification of a businesses cash position. This keeps the business from bouncing a check or missing an authorized deduction. Reconciliation also can help identify potentially fraudulent activity that might impact any of these accounts.
Believe it or not, there are a countless number of businesses where reconciliations are not done, and numerous others where they are not done properly. This results in errors within the bank and credit card balances appearing in the books. If a business is not performing monthly reconciliations of its bank and credit card accounts, it cannot be assured that all transactions related to the business are being reported within its financial reports.
Failing to Track All Expenses
Many small and large businesses fail to track all the out-of-pocket expenses encountered in day-to-day operations. An employee is driving back from a short business trip, the gas is low, he stops at a local convenience store to put just $5 worth of gas and fails to get a receipt. Yet he turns it in on his trip expenses, which are reimbursed along with several other expense reports.
You say it's no big deal. It's only $5. But what if that occurs with 10 or 20 employees every few days, of every week, for the entire year? The dollars add up.
While such small receipts may not be required by the IRS, they provide essential documentation for the many deductions you will claim as expenses for your business. They also insure your employees are being properly reimbursed for documented expenditures, which the IRS requires if you're reimbursing them in a manner that is not reported as income to them.
Improper Classification of Personnel
W2 or 1099
What defines an employee as opposed to an independent contractor? Failing to properly differentiate between employees and independent contractors (by any name) is one of the biggest mistakes a company can make – one that can be very costly indeed.
There is a tendency among very small and start-up companies to say, “I can’t afford employees right now, I will just show ole Joe as a 1099-contractor.” There are a variety of questions a company must answer in determining whether someone is an independent contractor or an employee.
When it comes to who should be classified as an employee and who should be considered an independent contractor, the key determining factor is “control.” It’s all about who controls the work performed.
Independent contractors set their own work schedule, use their own methods for performing the work, and supply their own equipment and tools-of-the-trade. Typically, they will have multiple clients, which means at the same time they are performing work for one specific client, they can accept or turn down work as they decide.
In contrast, employees typically have assigned hours and a set schedule. They complete work as assigned to them by a supervisor or manager, and they complete that work within a schedule or period defined by their supervisor or manager.
The equipment and tools they need generally are furnished for them, and they receive their training from the company. While some employees may work a part-time job on the side, they generally only work for one employer on a full-time basis.
Determining the classification status of personnel and clearly communicating this status is important for maintaining understanding between the parties and clarifying expectation in terms of taxation. We suggest you review this IRS website for more information about differentiating W-2 Employees from 1099 Contractors.
Similarly, understanding the difference in tax payment accountability between a W-2 employee and a 1099 independent contractor is important, because while the responsibility for withholding and paying taxes is different, the individual responsibility for payment is the same.
Expensing vs. Depreciating Assets
When purchasing property or equipment to build a business, items classified as assets must be added to the balance sheet and depreciated properly. Many small companies mistakenly expense purchases such as computers, machinery and office furniture, which should in fact be capitalized and written off over the useful life of each asset.
To identify and assist with proper classification, review IRS Publication 946 on depreciable assets or consult with your trusted accounting, bookkeeping or business advisor.
Just these five small bookkeeping blunders can get a small business into trouble in a hurry from both a financial and tax standpoint.
What these businesses need is the help of a trusted advisor like an accountant, bookkeeper or ProAdvisor to not only identify these gaffes and resolve them, but also guide and mentor them into a pathway that is set to assure their business succeeds.