5 Bookkeeping Mistakes Even Experienced Entrepreneurs Make
By: Hugh Pendleton, President
Bookkeeping is the window into the health of your business, but even experienced business owners make mistakes that impact its accuracy. After all, you didn't start a business thinking, "I can't wait to manage my bookkeeping!" You did it to realize your big idea and share it with the world.
Unless you're a bookkeeper, small errors are inevitable. These minor errors add up over time and lead to more significant problems down the road, which is why I want to review the five most common bookkeeping mistakes and how to fix them.
Mixing Business & Personal Expenses
Personal expenses are not business expenses. Look I get it, you're headed home for the day, you know there's money in your business checking account, and you just need to stop by the grocery store to pick up a few things. You think once or twice is ok, but eventually, your business checking becomes your very own piggy bank. Mixing business and personal expenses like this is defined as commingling funds.
When you use your business account for personal expenses, it throws off reporting for your real business expenses. Did you spend $500 on office supplies or does that include your last trip to Whole Foods*? It will also affect your deductions at the end of the year. If you can't prove that accurate, legitimate business expenses support your expense categories, you open yourself up to the severe risk of audit. Small business owners are much more likely than individuals to get audited by the IRS and categorizing personal expenses as business expenses is considered fraud.
And consider this—if you are audited and have personal expenses in your business account, you've just given away a piece of your privacy as an individual. While you own your business, you are not only your business.
Keep it simple by keeping personal expenses out of your business checking account. Transfer a set amount each month into a separate bank account and pay all personal expenses out of there. This will make your records much cleaner and make budgeting your business cash flow much simpler. Not to mention, Uncle Sam doesn't need to know how many nights you ordered take out and watched Netflix this year.
Miscategorizing Owner's Pay & Credit Card Payments as Expenses
Paying yourself is not an expense. Unless you are writing yourself a paycheck and paying payroll taxes, your owner's pay is Equity, and you should categorize it as Owner's Draw or Owner's Distribution. By calling your salary an expense, you'll skew your reporting and put your business at risk with the IRS.
Credit card payments may seem like expenses, but they're liabilities. This means that you have already recorded the expenses along with an offset to the credit card payable and when you pay the bill, it's just paying a debt (liability). This classification is necessary because if you use your credit card to pay for actual expenses and then also classify the pay-off as an additional expense, you're double-reporting. This will severely throw off your accounts payable, monthly reconciliations, and tax deductions. This is a pretty easy fix in your bookkeeping system. Simply relabel each credit card payment as a liability rather than an expense.
Let's face it. Whether you're tracking them or not, receipts are a royal pain. Throw your mind back to last April and let me paint you a picture. You're pulling together your records for your tax return, and you realize your receipts are all crammed in a file or shoebox accumulating dust. As you pull them out one by one, your heart sinks when you see some of the receipts are useless because they have faded to white. Others are torn, and you're pretty sure you remember a few that got blown out of the car while you were running errands.
Missing receipts can cost you tax deductions. You can write off a lot of your expenses if you keep good records and can prove they are legitimate business expenses. But on the other hand, if you claim deductions without the supporting receipts and get audited by the IRS, you could end up paying a lot of money in penalties.
To avoid these problems, switch to digital receipt records. Find a mobile app (there are tons, so pick whichever you like best) and take photos of every paper receipt. Any good app will pull the relevant info (amount, date, account number, etc.) and attach it, and the photo, to the correct entry in your bookkeeping system. Think of it as a Snap or Instagram story that will actually earn you money.
The payroll tax is one of the most complicated aspects of bookkeeping. The first mistake business owners make is mislabeling employees as contractors. You don't pay payroll taxes on behalf of contractors, so if you accidentally classify someone as a contractor when they should be an employee, you'll accumulate payroll taxes that you have to pay at the end of the year. And if you don't pay those taxes, you run into even more significant problems. A worker is an employee if they meet more than two of these requirements:
- You provide their equipment (computer, tools, software, etc.)
- They work out of your office
- They work under your control or supervision
- They don't have a contract
- They are paid hourly or earn a salary rather than being paid per project
Payroll taxes have a lot of different reporting requirements and include issues like benefits and worker's compensation. And the penalties for filing mistakes or failure to pay are huge. This is your employees' money, not yours, so the IRS views this money as a Trust Liability, not a tax and is aggressive about collections. The trust liabilities also attach to you personally regardless of any legal structure (like a corporation) that you think is protecting you. I know of one business that got behind in their first year and three years later are still struggling to catch up.
The most straightforward solution to avoid any disaster scenario is to hire a payroll provider like ADP, Paychex, or QuickBooks. Sign up for full-service. It costs a little more but is worth it. They take all the money out on payday to pay the taxes and file the reports. Even better, they take legal responsibility for all of the tax payments and filings. All you have to do is make sure there is enough money in the bank for each payroll. If you think a payroll service isn't in your budget, remember that the penalties for one small error are often substantial enough to pay for a full year's payroll service. You'll also save a ton of time and worry.
Reconciliations catch bookkeeping errors before they become a problem for your business. Well, they do if you complete them monthly. But with competing concerns like sales, marketing, and customer-facing projects, reconciliations often take a backseat until the end of the quarter. It's understandable, but missing reconciliations mean missed opportunities. They catch unauthorized transactions, bank errors, and unrecorded items, all of which impact reporting and cash flow.
You don't want to reach the end of the year and find out someone had a rager in Acapulco on your business credit card in July. You might think you'll notice something like this if it happens, but without regular reconciliations, you won't. This actually happened to a fellow entrepreneur of mine, and she wasn't able to cancel the charges with the bank because she caught it too late.
Don't let these common bookkeeping mistakes derail your business. Use these tips to improve your record-keeping. Or if you're still annoyed by the prospect of spending even more time making sure your bookkeeping is correct, get in touch with us. We'd love to talk and find out how we can take bookkeeping off your hands for good.
*Food bloggers, you're the exception to Whole Foods expenses. Keep those Insta-worthy meals coming.