This isn’t my article, you can find the original here, but I wish I’d written it. And now I’ve started giving a copy to all my clients when I meet with them. Not only does this highlight some very common problem areas but it is a good discussion starter on broader topics that may have been a concern but weren’t thought about to bring up.
It’s a long article so I’ve split it into two parts. I hope you not only enjoy it but if it brings question to mind about your own San Diego bookkeeper problems, headaches or uncertainties I hope you will give us a call so we can let you know how we might help.
Statistics from the U.S. Small Business Administration reveal that about half of all new small businesses launched in the U.S. will fail within the first five years. What is the chief cause of small business failure? Poor financial management.
Sound financial management starts with an understanding of some basic rules of business bookkeeping, so here are 10 of the most common accounting and bookkeeping errors made by small businesses — and how you can avoid making them.
1. Using the Wrong Accounting Method
There are two main business accounting methods: cash and accrual. Cash accounting is the simpler method because it’s based on the actual flow of cash in and out of a business. The cash method is used primarily by sole proprietors and businesses with no inventory. On the flip side, accrual accounting records income and expenses as they occur, whether cash has actually changed hands or not.
As they grow and become more complex, most small businesses should switch to accrual accounting, because this makes it easier to accurately match revenue to expenses. Otherwise, the business might look profitable during months with few expenses and unprofitable during months with large expenses, with no way of really knowing the difference.
2. Combining Personal and Business Finances
It’s critical that personal and business finances be kept separate at all times, regardless of a company’s size. That’s why one of the first things new business owners should do is open a business checking account and deposit all business income into this account.
The next step is to work with an accountant to devise an earnings management strategy dictating how cash is removed from the business to meet personal expenses and savings goals. Your earnings management strategy will be driven by such factors as how much of your profits need to be reinvested back into the company, the timing of payments for large business expenses, your cyclical or seasonal cash flow needs, and your long-term personal financial strategy.
3. Misclassifying Workers
In the eyes of the IRS, there are several different categories of workers: full-time, part-time, and temporary employees, as well as independent contractors, such as freelancers and consultants. Classifying your workers in the wrong categories can be extremely costly.
The employee categories are often used to determine who is eligible for employee benefits. Full-time employees are generally eligible for all benefits offered by an employer, while part-time employees may be eligible for a pro rata share of benefits. Temps and independent contractors generally receive no benefits, and independent contractors are not covered by minimum wage, overtime, payroll tax, workers’ compensation, or unemployment compensation laws.
4. Not Performing Basic Account Reconciliation
Reconciling your business’s books with your business bank statement every month is one of your most fundamental accounting duties.
Account reconciliation is relatively simple: Just compare your books with your bank statement and make sure there are no discrepancies. If there are, contact your bank right away to get them resolved. Doing this on a monthly basis helps ensure that accounting errors are caught and corrected quickly before they result in major financial problems.
5. Being Too Nonchalant About Petty Cash
Many businesses keep an informal stash of “petty cash” that can be used by employees to cover small and incidental business expenses, such as postage stamps, snacks from vending machines, and office supplies. But just because the amounts are small doesn’t mean that petty cash shouldn’t be accounted for properly.
A simple accounting system for petty cash logs the amount of money initially put into the stash and requires workers to submit a petty cash slip each time they remove money. The slips should total the original amount of money put in when the petty cash stash is exhausted, and then a new stash can be started with a new petty cash deposit.