10 Accounting Mistakes Business Owners Commonly Make
While business owners want to (and should) be involved in all aspects of their businesses, you don’t need to be an expert in every one of these aspects. Many owners wear multiple hats well; however, they find the bookkeeping/accounting hat a harder one to wear.
Financial mistakes can adversely affect your income statement (profit & loss), balance sheet, pretax profits, taxes, labor efficiency ratios, and business valuations. Not to mention it can garner unwanted attention from the IRS and damage reputations with vendors, customers, and employees.
Here are a few of the most common mistakes business owners make when it comes to their company’s financial data.
1. Procrastinating with Entering Transactions
Running a business in not just a full-time job, it’s a lifestyle. Focusing on sales, customer services, producing a product, or delivering a service combined with the daily fires of running a business, it can be easy to put off taking care of the books. Before you realize it, months have gone by and no transactions have been entered, the accounts have not been reconciled, and worse, tax reports and payments get missed. Without current data, financial statements are outdated, the health of the business is impossible to assess, and good business decisions become more difficult to make.
2. Trying to Overcome the Learning Curve of Accounting Software
With a focus on creating income, business owners may choose the wrong accounting software because it’s easier to use or not spend enough time to properly learn the correct accounting software they chose. Not setting up the software properly can lead to incomplete information or mis-categorized transactions creating incomplete or incorrect reporting.
3. Not Getting Owner Compensation Right to Get a True Pretax Profit
Owners/partners that work in the business need to make a market wage or your pretax profit will be overstated. Owners have a bad habit of underpaying themselves and taking more in distributions/draws. This overstates the actual pretax profit of the business, and depending on the legal structure of the company, can be considered tax evasion by the IRS. If your company can afford it, it needs to pay a market wage to its owners.
4. Mixing Business and Personal Finances
The most common mistake business owners make is mixing their personal and business finances. Besides the issue that the business profit is being used for the owner’s personal life, the IRS is strict when it comes to what can be written off as a business expense. This also negatively impacts the pretax profit and will distort the financial health of the company.
5. Throwing Away or Not Collecting Receipts
Despite the prevalence of the digital age, paper receipts need to be kept. These can, however, be digitized and stored electronically; but they must be retained in some format. Receipts assist when there are any mistakes or discrepancies in the accounting system. More crucially, if the IRS ever comes a-knocking, not having receipts can lead to denied deductions which result in taxes and potential penalties owed.
6. Not Knowing Your Labor Efficiency Ratio or How to Manage Labor Productivity
The key to profitability in any business is labor efficiency. The biggest expense for a business is payroll and it’s not about how many people you have or how much you pay them, it’s about how much productivity (gross profit) you get for every dollar of labor.
7. Budgeting Instead of Forecasting
A budget is basically a license to spend. You need a plan for making money, not a way to spend. Use a simple forecast model and update it monthly with actuals.
8. Not Ordering Your Cash Flow Properly
According to Greg Crabtree (Crabtree 2014), the four forces of cash flow should be ordered as:
1.) Paying your taxes
2.) Repaying debt
3.) Reaching your core capital target (building working capital)
4.) Taking profit distributions
This might be counter-intuitive to how you think this list should be ordered; however, if you want to have a truly profitable business, you need to follow this format when using your profit. Yes, sometimes that means not taking a distribution, but remember, you’re creating a profitable business, not a personal ATM.
9. Thinking Your Saving Money by Not Hiring an Accounting Professional
The majority of highly successful people will attribute their success in part to surrounding themselves with people who are smarter than them. Admitting that you’re not the resident accounting guru for your company isn’t a bad thing. There are situations where not getting professional help can lead to major issues.
10. Hiring the Wrong Accounting Person/Bookkeeper
Hiring the wrong person to do the accounting can not only lead to creating financial problems that lead to uneducated decisions, it can lead to audits and/or penalties. Hiring yourself, the inexperienced office help, or even a family member can create issues that haunt you and your business for years to come.
The wrong person won’t know how to invoice properly, may not have knowledge of tax laws, may not know how to properly classify expenses or create accurate journal entries, may not know what can be a business deduction and what has to be kept separate, and will not know how to interpret this data to best advise you on business decisions.
The right accounting professional will not only be knowledgeable about accounting practices, they will also have a track record with recommendations, certifications, and have knowledge of more areas of business than just accounting. By not Seeing Beyond The Numbers™ the wrong accounting professional may be able to keep you in the black and out of trouble with the IRS; however, they won’t be able to tell you what the numbers really mean.
Finally, doing your due diligence is important. If you don’t have the time, skill set, or knowledge to complete your own due diligence, we suggest using a service such as The Clear Business Directory. Having an unbiased third-party conduct due diligence on any business relationship is essential to not getting into bad contracts, deals, or relationships.
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CRABTREE, G. (2014). SIMPLE NUMBERS, STRAIGHT TALK, BIG PROFITS!: 4 keys to unlock your business potential. S.l.: LIGHTNING SOURCE.