As an accounting firm, we’ve seen our fair share of bookkeeping mistakes. But some are worse than others.
While some mistakes are relatively minor and can easily be corrected, others are far more egregious and can have devastating consequences. In this article, we’ll be talking about the more serious offenses; the ones that can end up being fatal to your business. We call these the deadly sins of bookkeeping, and we’re going to teach you how to avoid them.
Mixing Personal and Business Expenses
There’s a reason why the U.S. Small Business Administration (SBA) lists opening a business bank account as one of the first steps you should take when starting a business: it’s to protect you from any legal trouble down the road.
Since you’ll be filing your business taxes separately from your personal taxes, it’s very important not to get your expenses mixed up. If you do, the IRS may conduct an audit, and it will likely end up costing you in the end.
“If the IRS discovers that you deducted personal expenses as business expenses, they may charge a penalty for claiming false deductions and demand payment of the balance with penalties and interest if the filing deadline has passed,” Tax Defense Network warns. “The unpaid balance after removing the false deductions will be treated as back taxes if you do not pay them before the filing deadline.”
Unsure of what qualifies as a business expense? According to IRS Publication 535, a purchase must be both “ordinary and necessary” in order to be classified as a business expense and therefore deductible.
For example, let’s say you’re a self-employed photographer. You can write-off the fancy camera you just bought, but you can’t write-off a new car stereo system. You’d have a hard time convincing the IRS that the latter is both ordinary and necessary for your line of work.
Still uncertain about a potential gray area? When in doubt, speak to a tax professional who can maximize your deductions and minimize your chances of getting in trouble.
Not Keeping Track of (The Right) Receipts
Speaking of trouble, you’ll be in a world of it if you’re audited and can’t verify any of the deductions you claimed. The good news is, it’s not as hard as many make it out to be.
The IRS will accept statements from banks and credit cards as proof of purchase, contrary to popular belief that you must keep every last piece of paper.
But that’s not quite the end of it. There are some types of transactions for which you do still want to keep a paper trail.
The first kind is cash. In general, it’s best to avoid using cash for business expenses exactly for this reason. Not only do you have a harder time proving it if asked but it’s also easy for you to forget what you spent and lose out on deductions you could be getting. So if you do use cash for the business, get a receipt or at least make yourself a note that says how much, who you paid, and what it was for so you have a record. These may also be transactions which require a 1099 to be filed, which is another reason to keep good track of them.
The second kind of transaction that warrants keeping a receipt is the kind the IRS tends to look harder at which are the ones that could go either way. There are certainly legitimate times that a meal is a business expense, but it could also just be you going out for a nice family dinner. The IRS is much more likely to accept your claims of legitimacy if you have saved the receipt from each business meal and noted on it who you were dining with and a few words about what you discussed.
This goes double for expenses that involve travel. You might be able to write-off a trip to Hawaii, but you should have a real reason for doing so—a conference to attend, an investment to investigate, or a real sales opportunity. The better you can document this the more likely you are to not have these claims disallowed.
The old days of having to keep every single receipt are behind us but that doesn’t mean you still don’t have some work to do to make sure you get credit for all of your expenses on your books and on your taxes.
Inaccurately Categorizing Expenses
Did you know you may be costing yourself money by misidentifying the kinds of expenses that your business is accruing?
It’s true. We see it happen all the time.
For example, let’s say that you hire a consultant and mistakenly categorize this under regular employee expenses. Your accounting system will add standard employment taxes instead of the lower 1099 contractor taxes. Oops.
Here’s another example: let’s say you replace some broken windows in your office building. Well, as it turns out, ongoing maintenance and repairs are taxed differently than capital upgrades that could be amortized over time. It’s nuances like this can end up costing you in the long run.
How does miscategorizing expenses happen? In our experience, it boils down to three reasons:
- A lack of knowledge regarding expense types. You don’t know what you don’t know, so it’s hard to take advantage of tax breaks you’re unaware of.
- Not categorizing expenses at all. Some business owners don’t even attempt to categorize. Instead they use one big expense bucket. This can cost you in two ways: in time by having to sort it all out later, or directly out of pocket by paying a premium to whoever is preparing your taxes.
- Typos. It sounds silly, but it’s more common than you think. Mistyping the cost or putting in the wrong expense code can lead to miscategorization.
Of course, many business owners don’t even realize they’ve made these mistakes until a tax professional points them out. Yet another reason why we recommend using a tax prep service.
Skipping Bank Reconciliations
We get it. You’re busy and sometimes things fall to the wayside. But bank reconciliations aren’t something you can afford to skip out on. Allow us to explain.
Your current bank account balance isn’t always an accurate depiction of the money you actually have available since there may be pending transactions that have yet to settle. If you’re not paying close attention, you could overdraft your business checking account.
So how do you gain a better understanding of your cash flow and the exact amount of money you have available? By conducting monthly bank reconciliations.
A bank reconciliation is the process by which the balance listed on a company’s bank statement is matched to the balance listed in the accounting records. The purpose is to find out if there are any discrepancies and if so, identify why.
Discrepancies can occur for a number of reasons, from forgetting to record a transaction to a simple data entry mistake. In more serious instances, they can be linked to fraud.
The earlier you spot a discrepancy, the better, which is why bank reconciliations should be done on a monthly basis at minimum.
Inaccurate Financial Reports
It may not seem like a big deal to be off by a little here and a little there, but small errors do add up—and they can come back to haunt you in unexpected ways.
“Investors rely on financial statements to assess a company’s worth, while management relies on internal financial reports for sound decision making,” business correspondent Fraser Sherman explains. “Inaccurate reports can lead you to make bad decisions or make your company look less valuable than it is. They can also land you in legal hot water.”
Look no further than Hertz as an example of that. In December 2018, the car rental company agreed to pay $16 million to settle fraud and other charges filed by the Securities and Exchange Commission (SEC) stemming from erroneous financial statements and disclosures. Talk about a costly mistake!
Not Backing Up Bookkeeping Files
Now that you know how precious financial records are, it goes without saying that you should take every precaution available to protect them.
Just imagine what it would be like if you lost them. Not only would you have zero data to go off of for internal decision making, but you also wouldn’t have anything to show investors, creditors, or the IRS. Yikes!
The best way to prevent this from happening is to back up your files. We recommend saving them electronically both on a cloud server (such as Dropbox or Google Drive) and on your hard drive. If you want an added layer of security, print them out and store physical copies.
It may sound over the top, but accounts get hacked, natural disasters strike, computers get stolen, and hard drives crash. So make sure you’re prepared for every possible scenario.
Allowing Multiple Administrative Access to Accounts
Great bookkeeping comes with great responsibility. And if you have too many cooks in the kitchen, things can get a little messy.
We see this all the time when business owners share their administrative access with other people. It almost always leads to double entries and other inaccuracies.
Fortunately, there’s an easy solution. All you have to do is give each person their own login and assign them a level of access that is appropriate for their role. This simple step will save you a massive headache down the road. Trust us.
No Bookkeeping Policies and Accounting Procedures
Forget the seven deadly sins, we’ve got eight! And this last one is quite possibly the worst of all: not having any bookkeeping policies and accounting procedures.
Not having any bookkeeping policies and accounting procedures is a surefire way to sink your business. Not only can it result in real dollar losses, but it also puts you at risk of fraud.
And if you think you can just develop these processes “on the fly” think again, because that will only correct problems after they’ve already occurred, rather than anticipating potential issues and preventing them from happening in the first place. That’s why you should have written policies and procedures that hold employees accountable.
Running a successful business requires a long-term strategy. As Benjamin Franklin once said, “If you fail to plan, you are planning to fail.”
If you’re guilty of committing any of these bookkeeping sins, it’s not too late to right your wrongs; let us help you get back on the right path. You can repent to us over the phone at (858) 633-3573 or confess your bookkeeping sins via email at firstname.lastname@example.org. And remember: we’re not here to judge you. Only the government can do that.