LGT's Profit Sense

Many small business owners love running their business, whether it be creating a specialized product, offering a much-needed service, ensuring the success of a construction business, or whatever business venture that peaked their interests. As for the accounting aspect of their business – not so much. They may find it to be tedious, difficult, or time consuming. While I understand and appreciate the reasoning behind starting the business, every owner should be involved in their company’s financials. Unfortunately, many small business owners are not involved or do not pay close attention to the more critical issues. Here are the most common mistakes small businesses make and what owners can do to avoid them.

1. Inadequate Bookkeeping

It can be easy to overlook bookkeeping with the challenges owners face running their business. Business accounting requires that owners keep track of all transactions and ensure the booking of these items to reflect accurate financials. Common issues that may arise from inadequate bookkeeping include:

• Failing to track income and expenses could lead to underreporting income on a tax return, not being able to take advantage of possible deductions, and not having adequate information to make good financials decisions;
• Not reconciling bank statements and credit card statements with financial records could lead to misstatements, duplications, and/or omissions; and
• Ignoring small or miscellaneous transactions like petty cash or out-of-pocket expenses could lead to underreported expenses and incomplete financials.

Accurate bookkeeping gives owners a snapshot of how the business is performing at any moment. Without this information, they could miss signs of potential problems but also miss opportunities for growth.

2. Confusing Profits with Cash Flow

The amount of profit that businesses make only shows one part of the picture. Business owners should pay attention to when the money is received and how. For example, a business might work on a project that will bring in $75,000 and require five months of work. Cost to complete the project is an estimated $25,000. Using simple math, one would think that the company would make a $50,000 profit. Yet one would have to account for possible delays, cost overruns, and other problems that could interfere with the project. It is best to look at profits and cash flow separately and plan for any issues that may affect them both.

3. Overlooking Accounts Payable and Accounts Receivable

Managing bills that are due in accounts payable and managing customer payments yet to be received in accounts receivable are vital to the stability of the business and directly tie to cash flow. Failing to monitor these activities effectively could harm vendor relationships and leave the business unable to meet operational needs. Keeping this information up to date and consistently submitting invoices and statements to customers would help minimize issues in this area.

4. Not Distinguishing Between Contractor and Employees

Many businesses have contractors and employees that work for them. If the business has employees, there are wide ranges of legal responsibilities that go along with that. It has to withhold federal income taxes, Social Security, and Medicare taxes from employee paychecks, as well as pay its share of Social Security and Medicare taxes among other things.

Independent contractors are responsible for their own payroll taxes, which is why some small businesses tend to gravitate toward using contractors. That, however, comes with a bit of scrutiny. Employers that misclassify an employee as an independent contractor could face penalties, including fines payable to the government and damages owed to employees. A good way to mitigate this issue would be to review the business controls related to the work that is accomplished and review the permanency of the relationship between the business and the contractor.

5. Commingling Business and Personal Funds

It can be a challenge for small business owners to separate themselves from their business. There are times when it is more expedient for owners to pay business expenses from their personal funds. Even so, operating this way actually takes more of your time on the back end with gathering receipts, completing reimbursement documentation, and finding time to submit reimbursement. The best way to avoid commingling of funds would be to ensure that the business has a separate bank account and, for more convenience, a debit or credit card would be ideal and eliminate the need to complete additional paperwork. This also allows for more transparency between the business finances and personal finances.

6. Insufficient Tax Planning

Business taxes can be complicated whether it be a big business or a small one. The reporting and paying of taxes vary based on the structure of the business. Knowing what the requirements are can help ease the process of ensuring tax payments are made timely. A corporation, for example, pays taxes on its income and files IRS Form 1120, generally due by the 15^th day of the fourth month following the end of its tax year. A partnership or limited liability company (LLC), whose income passes through to the individual partners or members, would pay tax on their share of the profits, generally due by the 15^th day of April. Small business owners need to make sure there are sufficient funds are available to pay taxes when they are due.

7. Not Maintaining Digital Backup of Records

Digital security has become a business essential in this day and time. Security breaches, data corruption, and power failures are happening all too often, so it is important to have adequate coverage to secure business financials. Failure to have secure measures in place could lead to a financial nightmare. Data backups need to be scheduled routinely and should be stored at a secure location. Generally, records related to accounting and operations, tax returns, and employment are retained for at least seven years.

8. Trying to Keep All Bookkeeping and Accounting In-House

One of the biggest mistakes that many small business owners make is trying to do it all themselves. Accountants and bookkeepers are here to help with accounting, bookkeeping, and tax services. These specialized services help mitigate many of the accounting mistakes listed in this article and help small business owners gain a better understanding of their business, which are invaluable to the growth of a small business venture.

Avoid making common accounting mistakes because this often leads to costly financial problems, missed opportunities, and stunted growth of the business. Small business owners should prioritize accurate bookkeeping, distinguish between profits and cash flow, effectively manage accounts payable and accounts receivable, distinguish between contractors and employees, separate business and personal finances, plan for taxes, back up digital records, and seek professional help from accountants and bookkeepers. By avoiding these common mistakes, business owners will be better prepared to make informed decisions, promote financial stability, and gain invaluable guidance and growth for their business.

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If you have any questions or would like additional information about anything mentioned, please comment below or email us at askus@lgt-cpa.com.