Bookkeeping is a fundamental part of doing business. Regardless of whether you own a multinational corporation or a one-man online store, you need to keep track of your income, expenses, assets and liabilities. Many entrepreneurs do not have an accounting background, which is why they end up making major mistakes in the bookkeeping process. Some of these mistakes are irreversible or too costly to reverse. The financial impact of correcting them may even turn the table and eat away your hard-earned profits. This article presents some of the most common, yet significant, mistakes made by entrepreneurs. Keep reading to find out if you are doing it wrong and how to do it right.
1. Mixing Personal and Business Expenses
The first rule of business bookkeeping is the separate entity concept. It means that the transactions related to the business are always separate from the transactions related to the owner. You cannot spend your own money on a business unless you record it as a loan or investment in your business. Similarly, you cannot use business funds to pay off your personal expenses, unless you record it as loan repayment or investment reimbursement.
Most new business owners try maintaining a single bank account for their personal and business needs. Many also fail to mark the purpose for which funds were spent. The real problem arises at the time of tax return when you need to separately report the business expenses. In most tax regimes, only expenses that are incurred wholly or partly for the purpose of the business are tax-deductible. When you mix up the personal and business expenses, you are giving rise to two possibilities at the time of tax return. Either you classify some business expenses as personal expenses, which means you miss out on the tax deduction, or you classify some personal expenses as business expenses, which may result in tax penalties for misrepresentation. Get on the right track and start maintaining separate books and bank accounts for your business.
2. Not Maintaining Data Backup
The importance of data in the contemporary period cannot be emphasized enough. If you do not use cloud-based bookkeeping software or app, you are always at risk of losing your critical business data. Depending on the type and size of your business, the cost of data loss can be higher than the worth of your entire business. You may miss out on the details necessary for tax returns, the amounts owed by different customers, and even the information necessary to operate your business.
Regardless of whether you run a single-employee business or a large organization, you must strictly follow the data backup protocols. Have a policy of regular data backups at multiple sources so you are always prepared to survive disasters.
3. Mis-categorizing Transactions
Part of a bookkeeper’s job is to correctly categorize the transactions not just for the business owners but also for the tax authorities. An incorrect classification can completely change the tax treatment and mess up your books. For instance, in most tax regimes, you cannot claim a deduction for the full cost of capital expenditure in one year. Instead, you need to spread it across multiple years and claim deductions in each year. Similarly, when you spend funds on lunch, the deduction will depend on whether it was for the customers or the employees as one of these may be tax-deductible and others may be disallowed.
Learning the correct categorization may require time and effort. You need to research how the transaction is typically accounted for in your region and whether it is allowable for tax purposes. Some bookkeeping software can really help you in the process by automatically classifying the transactions.
4. Ignoring Bank Reconciliation
While bookkeeping is not science, it definitely involves a systematic process where you are required to perform periodic tasks. The success of one really depends on the completion of the other. For instance, you cannot prepare annual reports if you do not record daily transactions in the first place. Similarly, you cannot follow up with customers if you do not regularly record and dispatch the sales invoices. A critical task often ignored by entrepreneurs is bank reconciliation.
Bank reconciliation involves comparing your books with the bank statements to ensure that the balance perfectly reconciles. Even if it doesn’t reconcile, you should be able to track the reasons for discrepancies and adjust them over time. Many non-accounting business owners simply ignore bank reconciliation as they find it too challenging. Remember, you must carefully check every single transaction on the bank statement to ensure it has been duly recorded in the books. Managing monthly reconciliation is a lot easier than, say, reconciling the full 12 or 24 months.
5. Not Using Budgets
All businesses need a yardstick to compare their performance. You don’t know how well you are doing unless you have a pre-defined target. Many entrepreneurs spend their time and effort on business operations. However, in the absence of the target, they never know where and when to improve. Budgets not only act as incentives to motivate you but also allow you to understand the areas requiring improvement. With budgets, you know when to stop spending more and how exactly the expense will affect your long-term financial plan. Budgets make your bookkeeping a lot easier as you can easily identify an anomaly that is not in line with the budget. Remember, failing to follow your plan is planning to fail your business.
6. Using Manual Account Systems
We are living in an era of artificial intelligence, and it is pointless to spend hours and hours on manual activities that can otherwise be performed by computers. In relation to bookkeeping, if you are spending your precious time on manual entries and recordkeeping, you are missing the point. It is possible to completely automate most parts of your bookkeeping process by using paid or free bookkeeping software program. When a customer books an order, your website can automatically transfer the payment data to the merchant service provider, the information about stock availability to your accounting software and the request for invoice generation to your invoicing software. Many bookkeeping software involves the option of receiving payments directly from the emailed invoices, and some bookkeeping software automatically imports and classifies your bank transactions. What do you do? Well, you just sit back, relax and view your business grow. That’s how integrated bookkeeping can be.
Check out our guide on selecting an appropriate bookkeeping software for your small business so you do not end up with the wrong choice.
7. Not Seeking Expert Help
In some cases, it is better to accept the bitter truth and seek expert help instead of making matters more complicated. If you find it difficult to maintain your books or if you have made bookkeeping mistakes in the past, it is better to let an expert do their job. A qualified bookkeeper can take complete responsibility for recording the transactions so you can concentrate on expanding the actual business. Many entrepreneurs delay availing the services of an accountant, which increases the cost of streamlining the bookkeeping activities. Remember, you need to get the business workflows right at an early stage to enable efficient bookkeeping.
While bookkeeping is easy, making mistakes in maintaining the books is even easier. If you have been maintaining a single bank account for your personal and business expenses or if you have been using spreadsheets to manually enter the financial data, you are doing it all wrong. Correct bookkeeping can save you from tax penalties, high consultant fees, and data recovery challenges, thereby granting you peace of mind to focus on the actual business activities.