Bookkeeping blunders have the potential to significantly impact your profits. Fortunately, many of these costly mistakes can be easily avoided with proper precautions. Discover the top 5 financial errors frequently made by small business owners. freshbooks
Blunder 1: Blurring the Lines Between Personal and Business Finances
Bookkeeping is essentially the art of keeping a close eye on the flow of money in and out of your business. This involves meticulously recording and categorizing every transaction, while also maintaining a clear distinction between personal and business expenses.
The Pitfalls of Blending Personal and Business Finances
When personal and business finances are intertwined, it becomes challenging to distinguish between your expenses and income sources. Consequently, this places a heavier burden on your bookkeeper as they strive to determine which transactions are personal and which are related to your business.
Example:
Let’s say you’re a freelance designer working from home. You use one credit card for all your personal and business transactions. One day, you go out and buy a brand new, ultra-ergonomic office chair. Let’s say you’re a freelance designer working from home and using one credit card for all your personal and business transactions. When your bookkeeper sees a purchase on your credit card statement, they can’t determine if it’s for your home office or personal use. This blurs your financial records, making it difficult to assess your business performance and potentially missing out on tax deductions. Miscategorizing transactions can also lead to IRS trouble if personal expenses are claimed as business deductions during an audit.
How to Avoid It
To prevent the blurring of personal and business finances, it is crucial to establish separate bank accounts for your business and personal funds. Make sure to deposit all your business income into the designated business bank account. Additionally, obtaining a business credit card and using it solely for business purchases can help streamline your bookkeeping process.
By implementing these measures, your bookkeeper will only need to monitor your business accounts. This ensures that any transactions appearing on your statements will be accurately recorded in your business books. With no room for confusion or mixed-up transactions, you can confidently assess your business performance and avoid potential issues with the IRS.
Mistake 2: Allowing Tax Time to Catch You Off Guard
Tax season arrives like clockwork every year. It shouldn’t come as a surprise to anyone. However, it’s all too common for entrepreneurs to procrastinate on their tax responsibilities. By neglecting their bookkeeping duties throughout the year, they find themselves in a chaotic mess when it’s time to file. Not only does this cause mental and emotional stress, but it also has serious negative consequences for their business.
The Consequences of Neglecting Tax Preparation
Filing taxes late or incorrectly can result in charges and penalty fees from the IRS. Disorganized bookkeeping during tax season can lead to missed deductions. Not preparing for tax time may require additional fees to catch up on bookkeeping. Failing to keep books updated throughout the year hinders understanding of business finances and decision-making.
How to Avoid It
Knowing your tax filing deadlines is crucial to avoid surprises or penalties. Deadlines vary based on your business structure:
– S-corporations and partnerships: March 15, 2023
– Individuals and sole proprietorships: April 18, 2023
– C corporations: April 18, 2023
If you anticipate not being able to file on time, prepare for a federal tax extension to avoid penalties. Consider hiring a local bookkeeper or using an online service like Bench to establish reliable bookkeeping. Obtaining end-of-year financial statements is essential for calculating and filing your taxes accurately.
Mistake 3: Forgetting About Cash Flow
Cash flow is the lifeblood of your business, representing the amount of money flowing in and out, as well as where it goes. Failing to stay on top of your cash flow can make it increasingly difficult to meet your financial obligations and pay your bills on time.
The Dangers of Neglecting Cash Flow Management
Don’t have a clue about how much you owe this month? Uncertain about how long it takes to get paid? Completely unaware of the expenses your savings can cover in case of an emergency?
That’s what happens when you neglect tracking your cash flow. You’re left in the dark, vulnerable to unexpected expenses and the risk of falling short when it’s time to pay. This can have a devastating impact on your financial well-being.
While it may be possible to get away with haphazardly tracking cash flow when your business is small and simple, ensuring you have enough to cover bills and pay yourself each month, it becomes increasingly challenging as your business grows and becomes more complex. With more expenses and sources of income, it becomes harder to keep track.
How to Avoid It
The key to avoiding cash flow troubles is to establish a robust bookkeeping system. Specifically, you must prioritize obtaining monthly cash flow statements. Accounting software can handle this for you, as long as you keep your books up to date. Alternatively, you can enlist the help of a professional bookkeeper to handle the task.
The best course of action is to start tracking your cash flow now, regardless of the size of your business. By doing so, you’ll gain a clear understanding of your financial standing and be prepared for any future growth and complexity.
Mistake: Overlooking Valuable Tax Deductions
Many of the expenses you incur while running your business can actually be deducted from your taxes, saving you money in the long run. For example, if you designate part of your home as a dedicated office space, you can deduct a proportional amount of your rent or property taxes. Additionally, if you use your phone for business calls, you may be eligible to deduct a portion of your phone bill. Even something as simple as having a casual business meeting in a coffee shop can result in deducting the cost of two cappuccinos. These deductions can add up and significantly impact your overall tax liability.
Why Missing Out on Deductions Is a Bad Move
The more expenses you can deduct from your taxes, the less you have to pay in taxes. It’s like getting free money from the government that you’re entitled to. All you need to do is make sure you keep track of these deductions and report them accurately.
One of the biggest reasons why self-employed individuals miss out on deductions is because they don’t have a system in place to track them. It’s easy to overlook expenses when you’re running a freelance business on the side and then suddenly find yourself dealing with tax season without a clue about what expenses you can report.
Another reason why freelancers miss out on deductions is that they often choose the standard deduction instead of itemizing their expenses. While you may have always opted for the standard deduction on your taxes, it may not be the most lucrative option now that you’re running a business.
How to Avoid It
Having accurate and up-to-date books is crucial for tracking your business expenses. Your books serve as a valuable resource when it comes to determining which expenses are deductible.
In addition to maintaining accurate books, it is highly recommended to seek the assistance of an accountant. They can guide whether you should choose itemized or standard deductions, helping you maximize your savings. Furthermore, they can help you identify which expenses you can report to the IRS and which ones you cannot.
Mistake 5: Throwing Out Financial Records Too Soon
After the tax season has come and gone, and you’re ready for some spring cleaning, it can be tempting to get rid of your old business records. However, before you start throwing them out, it’s important to know which records you need to hold onto for tax purposes.
Once tax season has come and gone, and the urge to declutter hits during spring cleaning, it can be tempting to dispose of your old business records. However, before you give in to the temptation, it’s essential to understand which records are crucial to hold onto for tax purposes.
In the event of an IRS audit, not having the necessary records to support the deductions you’ve claimed on previous tax returns can result in penalties. Even if the likelihood of being audited is low, it is highly recommended to hold onto all tax records as a best practice. The effort required to do so is minimal compared to the potential trouble you could face if you don’t have the necessary documentation.
How to Avoid It
Make sure to keep a record of every receipt, and make it even easier by using an innovative online tool like the BPT. This amazing solution scans your receipts and organizes them automatically into different expense categories. With this convenient system, you’ll never have to worry about losing important receipts or struggling to keep track of your expenses again.
And don’t forget: Hold onto all your records for a minimum of 3 years. This is because the statute of limitations for your tax return is 3 years, during which time you can make amendments and be subject to an IRS audit.
So, if you have records for your 2023 tax return, make sure to keep them until after you’ve filed your return for 2027.
Of course, there are a few exceptions to this rule:
– Employment records for your employees: Keep these records for 4 years.
– Employee benefit records: Hold onto these for 6 years after the employee leaves your company.
– Returns and supporting documentation where you omitted more than 25% of your gross income: Save these for 6 years after you’ve filed or after the due date of the return, whichever is longer.
– Records for the cost of bad debt or worthless securities you deducted on your tax return: Keep these for 7 years after you filed or the due date of the return, whichever is longer.
– Supporting documentation for returns you failed to file or for fraudulent returns: Save these records indefinitely.
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