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The majority of small businesses that I work with founded their businesses and developed their clientele because of a genuine love for what they do. They love the service they provide and they love the customers who pay for that service. Very rarely, with the exception of some of the accounting firms that I work with, do I meet with a businesses owner that went into business because of a love of bookkeeping and tax preparation. Imagine a small-town Mexican restaurant with the slogan, “The cleanest Profit and Loss Statement in town… the margaritas aren’t half bad either”. It’s safe to say I wouldn’t be eating there.
When I sit down to meet with potential clients, the first thing they usually communicate to me is their disdain for bookkeeping. I completely understand. As a small business owner, you have several hats to wear everyday and keeping clean books can sometimes get put on the back burner. However, getting your books in order at the end of the year is a necessity to ensure you’re not leaving any money on the table when you turn everything in to your tax preparer. It also sets a solid foundation for next year’s financial outlook. So, along with all the other tasks that fill your calendar during the holidays, getting your books in order should really be one of them. It may not be as painful as you have been imagining.
Understanding the Basics
In one of my previous blog posts I went over what a chart of accounts is, but it is such an integral part of your business’ financial playbook that it’s worth covering again. Your Chart of Accounts or COA is a master list of all your accounts. It covers everything from assets, liabilities, equity accounts, revenue and expenses. I have worked with clients whose COA’s have ranged from too skimpy (trying to jam all your accounts in to too few categories), to COA’s that were overly complex and frustrating to make sense of. So you want your COA to be small enough that it is easy to follow, but large enough to be all inclusive with enough categories for all your transactions.
The importance of categorizing your expenses properly for tax purposes really can’t be overstated. You see, your CPA isn’t going to be able to go in and make changes to your COA, they are only going to have access to your profit and loss statements and your balance sheet, so if you have miscategorizations in your COA it will throw off your year end taxes. This will make for a confused/frustrated accountant (frustrated accountants are usually more expensive accountants). This will also increase the likelihood of having to file for extensions, opening you up to penalties.
Benefits of Accurate Expense Categorization
Getting all your ducks in a row before the first of the year with regards to expense categorization will help your business come tax season in several ways. It allows you the confidence of knowing that you were able to claim all available tax deductions and credits. This will roll into significant savings and it also means you will be in compliance with tax laws. Accurately categorized expenses will also allow you to effectively track your business’ financial performance and it will help in forecasting and budgeting for the coming year. Although expense categorization may not be what pulls you out of bed in the morning, I think we can all agree that the amount of time and money that can be saved makes it totally worth it.
Common Pitfalls in Categorizing Expenses
The most common mistake that I see businesses make is paying their contractors out of a generalized or “uncategorized” account. Mis categorizing contractor payments will result in a skewed representation of what you actually spent on services received and causes you to pay too much to Uncle Sam. The other common mistake I’ve seen all too often is in regards to personal expenses. Anything that can be traced back to a personal item needs to be recorded as an “Owner’s Draw”- this will be the equity account in the COA. If you can sidestep these two traps that I see so many people fall into, you will be money ahead when you contact your accountant at the beginning of the new year.
Best Practices for Year-End Book Preparation
Along with seeing all the mistakes that businesses make, I have also come up with some tips to help you more conveniently setup your financial documents. Run the profit and loss statement for year to date by month and look for patterns in your spending. This is going to give you the best look at any inconsistencies with what you have recorded and will give you a solid foundation for next year’s budget.
I would be remised if I didn’t point out to you that QuickBooks (QBO) offers customizable reporting, allowing you to save reports for future use. QBO also gives you access to workflow templates that will help you streamline the year-end closing process. Technology has made all facets of our lives’ easier and keeping track and recording your business’ books is no different.
Your business’ books tell a story. It’s the story that the government is going to use every year to determine how much money you need to give them. It’s the story that potential investors and banks are going to read when making decisions on whether they want to invest in your company. And it’s the same story that once you get efficient at reading, will tell you where in your business you are excelling and where you may need to spend some time bringing it up to speed.
You didn’t go into business because you love the intricacies of bookkeeping and accounting, but it is still a requirement. I’m here to help. I hope some of the information that I have shared with you has helped you gather a gameplan for how you are going to get your year-end closing documents together. But if like many, you still want nothing to do with it, give me a call or shoot me an email and I’ll take care of you.