As a small business proprietor, it is essential that you are involved in all aspects of your company, and thanks to available accounting applications and software, it is easier than ever to keep track of your business progress and growth.
While accounting software has made recording and bookkeeping faster and easier for small business owners, you could still make accounting mistakes that could put your company in jeopardy. Some of these common bookkeeping mistakes are minor, insignificant, and even easy to correct. However, there are more severe accounting mistakes to avoid to prevent any problem with your business’s financial health.
Poor accounting practices, repeated over time, could distort the reality and standing of your business’s well-being. They could adversely affect your bottom line, clog cash flow, and could even attract unwanted attention from the IRS.
This article examines five common business accounting mistakes that business owners make and explains why they could create problems, both big and small, for your small business. Read and learn about them, so you know what and how to avoid them.
1. Uncommitted Bookkeeping
An essential key to a successful small business accounting is to record everything from small payments to large transactions from clients and customers. Bookkeeping requires you to register every business financial matter to have a reliable accounting process. Ensure that everything that happens in your company, no matter how small it might be, is recorded and categorized correctly.
Despite its importance, new business owners, especially those with small companies, often treat bookkeeping with an ad-hoc attitude. This is one of the most common accounting mistakes employers make, as this leaves your business vulnerable to losses, unpaid and late bills, or incorrect tax returns.
While it can be a good tool in the early stages of a business, owners would depend on excel spreadsheets to accomplish their bookkeeping. However, as the business grows, solely relying on excel spreadsheets could become increasingly difficult to manage.
Another bookkeeping mistake to avoid is not including your bookkeeper (if you have one) in the loop of all transactions. Complete and transparent disclosure of business-related information to your bookkeeper is crucial so you can monitor all of your income and expenditures easily.
Establishing a severe accounting and bookkeeping system for your business is essential to maintain a financially secure position.
Complete and accurate bookkeeping would provide you with a full picture of your business’s performance and growth in a given period. Proper bookkeeping practices would also increase your compliance when auditors use it as a reference.
Get into the habit of using formal bookkeeping software systems, preferably cloud-based ones. This would help you automate the recording of transactions and makes bookkeeping more manageable. The software also eliminates the risk of human error, reducing the time it takes to accomplish the task.
2. Late and Irregular Reconciliation
As small business owners, you are mainly tasked with doing many jobs that cause you to put off accomplishing bookkeeping and reconciliation later than scheduled. As reconciliations help you distinguish any unusual transactions resulting in non-compliance, doing such tasks at the end of the week or month is a risky strategy that could lead you to fall behind on financial statements quickly and reports, payments, and even customer billings.
Last-minute reconciliation is an accounting mistake that could jeopardize your business in the long run. This bad practice could result in penalties, invoicing errors, increased debts, bounced checks, and other accounting errors that could go unnoticed for extended times. You could also miss significant financial opportunities and experience cash shortfalls from snowballing bookkeeping mistakes.
Struggling or rushing to catch up on your books is an easy and fast way to make costly mistakes. Another reason for late or irregular reconciliation is not communicating every financial business deal with your accountant or bookkeeper. Small purchases and expenditures, especially with recurring monthly costs without reporting them correctly, could lead to significant problems and add unnecessary tasks to update them.
Small business owners could also verify their cash flow with the help of reconciliation. They typically work with smaller amounts of capital compared to bigger companies and corporations. Proper resource accounting provides transparency on your business’s precise cash position.
3. Unplanned Inventory Purchases
Planning and managing inventory purchases is both a skill and a balancing act that requires detailed attention each day. You should know when you have enough inventory to fulfil customer demand while at the same time knowing when to avoid investing too much money into inventory.
Purchasing inventory automatically ties up your business’s cash, which you cannot recover until you sell the inventory. This makes it hard to have cash flow when you overstock inventory. There are also cases when you have too little inventory to meet the customer’s demands, which could lead to loss of possible revenue.
Determine the dollar amount of ending inventory you can store on hand at the end of each month. Avoiding this common bookkeeping mistake limits you to handle necessary inventory without too much excess. You could calculate the amount on a percentage of monthly sales (say 15 percent of every month).
Ending Inventory Formula
Use the ending inventory formula to plan your purchases. Add the beginning inventory for the month with the purchases, then subtract the sales of the month. This would give you the ending inventory, which would help you fill an order for the following month during the first few days without waiting for a fresh batch.
You could also change the variables in the formula to suit your needs and better manage your inventory. The inventory formula ensures that your business maintains an adequate amount of stock, minimizing the cash needed for purchasing said inventory.
For example, an office supply retailer reports a beginning inventory of 500 units of staplers, and the shop expects around 1,700 stapler sales for the month. If the retailer needs 170 staplers (equivalent to 10 percent of forecasted sales) in ending inventory, the total number of staplers purchased should be 1,370 staplers.
1,700 expected sales + 170 ending inventory – 500 beginning inventory = 1370 purchased units
4. Assuming and Forecasting Cash Flow
New business owners often do not have an accounting background, especially for small businesses or companies. This creates accounting mistakes that could affect the general well-being of a business. Some employers confuse profits with cash flow, leading to bookkeeping mistakes.
Meanwhile, if you do not have enough cash to operate smoothly, issuing debt or selling equity could help you raise funds. Issuing debt involves principal and interest payments, and selling equity requires that you sell a percentage of ownership to a third party. Business owners running short on cash could stem from too much inventory and unplanned purchases.
While some owners assume that generating profit means a positive cash flow, there are cases where a business can be profitable but still experience a negative cash flow. These could lead to dangerous situations running the risk of insolvency or bankruptcy.
Some employers also make the accounting mistake of counting all their chicken before the eggs even hatch. For example, your company closed a $100,000 deal, which would take five months to accomplish and cost $60,000 to fund. You subtract the project cost to the deal amount and book a $40,000 profit before delivering any result.
Making this bookkeeping mistake could hurt your business more than it would do good. What if the project costed more than the estimated fund? What if you run into an issue causing the project to last a month longer? These are factors you should always consider when creating cash flow.
Understand your cash position and what outside and inside influences could affect it. Identify the essential vital drivers of your business’s cash flow so you could manage costs better and help improve your bottom line.
Cash Flow Roll Forward Formula
Create a cash flow roll forward by adding the beginning cash balance to the cash inflows then subtracting the cash outflows. This would give your ending cash balance for the month, which becomes the beginning cash balance for the next month.
Each month is connected. This means that the beginning cash balance of the current month was also the ending cash balance from the previous month. You receive payments from your customers as cash inflow, and you pay for inventory purchases, employee payroll, and other operation and overhead costs.
Update your cash flow roll forward each month to keep your business on track and help you avoid this common bookkeeping mistake. As much as it is tempting to book and record each deal as income when they are closed, it would instead make your business seem healthier than it actually is. This would give you a misleading picture of your company’s overall well-being.
5. Mixing Personal and Business Accounts
Personal finances and business accounts should always stay away from each other as much as possible. Small business owners often mix their individual personal accounts with those of their business. This is understandable, especially for new companies, as owners may use their personal funds to operate for the first few months. However, making this accounting mistake could spell disaster in the long run.
Blurring the line between the two financial accounts could make it harder to distinguish your personal and business transactions. This makes bookkeeping a nightmare, especially when you do not have a record of every expenditure or purchase.
Mixing both financial accounts could also create a big headache when the time comes to file taxes. This bookkeeping mistake could cause you to miss expenses and other deductibles. You could also have problems when applying for a loan or a line of credit. Lenders and banks want a complete and accurate picture of your business’s financial status when they consider your application.
Set Up Separate Bank Accounts
After successfully registering your business, set up a separate bank account for your business and personal accounts. Obtain an Employer’s Identification Number (EIN), as it is legally required to create a bank account for business purposes.
Open a business savings account and then a checking account to help you organize and plan your funds and taxes. You could also consider applying for a business credit card to start up your business credit. This step could aid in building wealth for future investments and save precious hours of work when accounting cash flow such as deductible expenses and purchases.
If you have been mixing your personal and business bank accounts, distance yourself from that accounting mistake. A dedicated business account will even limit your legal exposure to business debts if you have an LLC or corporation.
Good to Know: Pros and Cons of a Limited Liability Company (LLC)
Be very mindful of your spending decisions and make sure that business-related costs only come from business accounts. The same principle goes for your personal expenses and personal account.
When it comes to managing and growing a small business, owners tend to wear many hats, but some have a more difficult time with the accounting aspect of the business. This leads to accounting mistakes that could break your business.
Learning how to avoid them would help you manage and operate your business better without the worry of headaches. If you still struggle, such as doing payroll, you could always hire a professional or use online software to help you out in areas you need most.