Top 10 Accounting Mistakes Small Business Owners Make

Many business owners may fall into the trap of making some or all of the mistakes listed below. What often seems like a minor accounting error can often have significant consequences for your business’ finances. I have talked to dozens of business owners who thought they did not need an accounting professional handling their work because they are smart enough to do it themselves or because “accounting stuff just isn’t that difficult”. While this may hold true for some, especially business owners with a background in accounting or finance, it definitely does not hold true for all. This is particularly true because you don’t know what you don’t know and when it comes to accounting and finance, and this is an area you really do not want to mess up or make unnecessary errors because it can lead to very costly fines and penalties and in some cases, jail time. Additionally, true accounting professionals are able to provide guidance or assistance with many things that new business owners may be unaware of that need to be handled each month, quarter, or year – such as filing sales tax or filing an unclaimed funds report (which is required for all businesses in Ohio to file annually, regardless of whether there are any unclaimed funds to report).

Check out our list below of some of the most common and most consequential accounting errors that small businesses make.

1. Not implementing the proper systems

Many new business owners do not see the necessity of having an accounting system, even something as simple as QuickBooks (which by the way, comes in a variety of packages – Online or Desktop with multiple tiers to choose from with different pricing for each). Having a system in place to track your sales/income, expenses/bills, money due from customers/accounts receivable (if applicable to your business), and even inventory management is crucial for your business to properly track profitability and for future business planning. Trying to track this information in excel or google sheets will take up more time than it is worth, time that you, as a small business owner, could be using to generate new business.

After enough growth, it may also be worthwhile to look into various systems for bill pay or customer invoicing as these tasks can quickly become very time-consuming, taking away more of the time you could be using to grow your business. Some examples of this would include “outsourcing” your payables by adding bills into a system like bill.com or Routable, cutting out having to write and mail checks, manually process ACH/wires, and vendors already using these systems would cut out the time it takes to track their address information. Additionally, these systems can often integrate directly with your accounting system so you only have to record the information once – all of which can be HUGE time savers. Examples of customer tracking could include systems like Stripe or Braintree and the same reasons above apply here as well. Keep in mind though that these systems may be too costly to implement right away and should probably only be considered after your business has grown to a certain point.

2. Mixing business and personal purchases

You know the saying “don’t mix business with pleasure”? The same is true for mixing business and personal within your business. I have had probably a dozen clients over the past few years that have mixed their business and personal accounts – this is much more common for new business owners as it takes time to operate your business only on business income and toward the beginning having to contribute your own money into the business is very common. Although it is common and perfectly acceptable to contribute personal funds into your business, you should keep these things separate and should be put into a business bank account that is only held for business purposes. In addition to having a business bank account, you should investigate whether you need to have a business credit card as well. This may not be applicable for all new business owners, but if you want to use a credit card in your business (sky miles add up right?) make sure to have separate personal and business cards.

Side notes on business accounts: there are tons of options when deciding which bank or credit card company to use. Be sure to take the appropriate amount of time to research and investigate the different banks or credit card companies to get the most bang for your buck. Many new business bank accounts will offer some sort of cash reward if you sign up and deposit or spend a certain amount of money within the first 1-3 months of opening the account. Additionally, there are some options that are 100% virtual and others that have virtual and in-person branches depending on what you are looking for. These types of things are great to discuss with your accounting professional (and if you don’t have an accounting professional here is another good reason to seek one out).

Back to the intermingling of business/personal: intermingling these expenses opens you up to a plethora of questions from your accountant or from the IRS. Due to this, you have to track expenses much more closely, you will have to be way more involved with your books than is necessary (remember, you want to free up as much time as possible to generate new business or focus on growth), you are giving your accountant (or whomever is handling your bookkeeping) much more access to your personal records than needed, and finally you are opening yourself up to a lot more risk in terms of being audited each year as well. This is just to list a few reasons that mixing these items is a bad idea – it is not worth the extra time, effort, and risk to keep intermingling personal & business.

3. Forgetting about upcoming taxes / not properly planning for tax season

Planning for tax season is a drag – even for accounting professionals (except for those weirdos who love taxes). As a small business owner, you need to plan for tax season whether you are a sole proprietor (where income flows through to your personal return) or whether you are setup as a corporation (income is taxed at a business level and your business will have its own return). It is critical to properly plan for tax season and ensure you have the appropriate funds to cover any taxes that may be due – especially if you do not pay quarterly estimates throughout the year (if you do not know what quarterly estimates are or how to calculate them, you may need to seek advice from a tax accountant).

A few helpful tips or things to be aware of for tax planning:

• Sole proprietors do not have payroll, and thus must pay 15.3% self-employment tax on all income. This tax covers Social Security and Medicare taxes (when working as a W2 employee, you typically pay half of these taxes while your employer pays the other half).

• Corporations pay their owners & employees through payroll and cover HALF of the 15.3% Social Security & Medicare tax (which is a business deductible expense), while the employee pays the other half (deducted from their paychecks).

• Corporations are also able to pay distributions to their owners, which is not taxed at the company level but flows through to their personal return and tax is paid there – these distributions are considered income to the owner.

• It may be worthwhile discussing with your tax accountant any helpful business purchases and plan these around tax season to limit total income and thus limit how much you pay in taxes each year.

  • Some examples of business purchases could include: buying a new company car (not applicable for all business owners and the vehicle purchased must be used for business NOT personal) or buying a new piece of machinery or equipment (such as a business laptop for a new employee).

  • There are many more examples we could list here, but it is easier for you to discuss this with your tax accountant as they will have some helpful tips/tricks depending on your business, after all each business is unique and their needs are unique – trust me, they get these types of questions ALL THE TIME!

4. Struggling with Classifications

Many new business owners do not know how to properly classify their income or expenses, which can influence their total tax liability – especially with things like meals & entertainment (some meals are 100% deductible, others are only 50% deductible, and some are not deductible at all). Depending on whether your business is set up on a cash or accrual basis also affects how income/expenses need to be recorded. For example, a cash-basis business recognizes income and expenses as they happen/as cash changes hands. Whereas accrual-basis accounting recognizes income and expenses in the month they occur.

Example: in January you buy an annual subscription for your QuickBooks Online for let’s say $1,200 – under cash-basis you record the entire $1,200 under “dues and subscriptions” in January / whereas under accrual-basis you record the $1,200 to “prepaid expenses” and recognize $100/month from January-December under “dues and subscriptions”.

Certain types of income need to be classified in a specific way, such as each new contract with a new client needs to be tracked to the individual contract level. Additionally, there are new revisions to revenue recognition all the time, such as ASC 606 which directs entities to recognize revenue when the promised goods or services are transferred to the customer and the amount of revenue recognized should equal the total consideration an entity expects to receive in return for the goods or services.

Expenses also need to be classified in a specific way and sometimes new accounts need to be created to properly track the information. This can vary from expense to expense and from business to business. Creating sub-accounts for certain expense types can also help business owners track their expenses to know where they are spending the most money.

Example: payroll is typically the largest expense for most employers. If you are putting all the salaries & wages into 1 account, but you have 5 different departments, you may not know which department is costing you the most money. However, you can create multiple sub accounts for each department so you can track how much each department is spending and have a better understanding of where your cash is being spent.

5. Not tracking business costs or income accurately

Many new business owners may underestimate expenses or overestimate revenue. This can cause major issues when trying to understand your cash flow. Failing to record expenses such as small expenses like office supplies (paper, pens, staples, etc.) can quickly add up and failing to account for these items inflates total income and if not fixed in time could cause an increase in tax payments (higher income = higher taxes paid). Additionally, many small business owners may not think to reimburse themselves for company expenses they are paying for personally, such as internet, phone bills, or home-office expenses.

• Be cautious here though, not all businesses or business owners can reimburse themselves for these items. If you run your small business from your home and do not have a company phone and instead use your personal cell phone for business purposes, then a portion of your phone and internet bills may be reimbursable. If you are unsure about whether to reimburse yourself for these types of items, that would be an excellent thing to bring up with your accounting professional.

6. Forgetting to pay invoices

Here is a big one. Have you ever opened a bill with every intention of paying it right away but then got sidetracked by something else (like your kid climbing onto the counter to try to sneak some candy) and then forgot about that bill? It happens more than you would think, and with your business this could cause some major headaches. For example, if that bill you forgot about was to a supplier and after 60 days of being unpaid, the supplier decided to cut you off on any new supplies until the bill was paid, this could cause huge disruptions in your supply chain management. On the other hand, maybe the bill was not that critical, and you just got some follow-up calls or emails from your vendor, and they want their bill paid. Either way, you don’t look great by forgetting to pay your bills.

This ties back to having the proper software or systems in place. With the proper software (such as bill.com or Routable) this is much less likely to happen. Having an accounting professional who notices the same monthly expenses being paid then all of the sudden is not paid for a month or two and points that out also limits the likelihood of this happening. Setting up as many bills as possible to be auto-pay also really helps. Don’t let this happen to you – put the right systems in place.

7. Inefficiently managing billing

It is very important to send out invoices or collect payments from customers in a timely manner. Not invoicing customers timely can lead to cash flow problems, especially because not all customers will pay on time. Not having proper tracking in place to know which invoices are outstanding vs. paid can add to this issue as well. When customers inevitably try not to pay you, not having a proper collections process in place can further add to the issue. This also ties back in to having the proper systems in place to be able to track who still owes and how much they owe – using a proper accounting system drastically reduces the issues that may arise from billing. Keep in mind though that no matter how good your systems/processes are, if you do not create the invoice or tell your accountant about the money that is due, you may never end up getting paid.

8. Missing the signs of fraud

Fraud happens everyday and is becoming more common in our increasingly digital world. As a small business owner, you need to be aware of both internal and external fraud attempts.

Internally: you need to review books on a frequent enough basis that you understand where cash is coming or going to catch if there are “cash out” transactions that should not be happening. For example, you may have an employee that has their own company card or has access to checks and decides they want to use your company’s funds to buy their groceries or that exquisite new dress they saw at Macy’s. You need to have the proper controls in place to avoid these types of fraud attempts – which may include a spending limit, reviewing each transaction yourself (or having your accounting professional review each transaction), or requiring receipts for every purchase made on their card (this last one you should do regardless of the circumstances).

Externally: keeping an eye out for phishing attempts from unknown email addresses or senders that look a little off (for example my email is drew@epaccountsoh.com but someone trying a phishing attempt may send you an email from drew@epoccountsoh.com – did you notice the difference?) – being aware of these and keeping that extra eye for detail is crucial. Additionally, verifying any changes in banking info or address changes directly with your vendor if requested via email or some other method is the most important thing you can do to limit fraud. If you receive an email from what appears to be your vendor asking to change where you send checks or asking you to update their account with new banking information for ACHs/wires, you should always reach out to a known contact and verify the information with them before making any changes.

9. Failing to classify employees properly

Many new business owners are new to payroll and how to manage associated tasks with their employees. Classifying your employees correctly is very important because mis-classifying them can lead to problems with how much you pay in unemployment, missing or sending the incorrect tax forms at the end of the year (1099 vs W2), or under/overpaying payroll taxes (such as Social Security, Medicare, or even local taxes – which may not be your fault, but doesn’t mean you won’t take the blame from the employee).

Some helpful tips/information on employee classifications are below:

• W2 employees & 1099 contractors have specific requirements to be considered an employee vs a contractor & knowing these requirements is vital to how you pay them, how you file payroll taxes, and what tax forms you as an employer need to send out at the end of the year.

  • A few quick examples: to be considered a 1099 contractor, the contracted “employee” must be in control of their own hours, they have the right to control or direct the result of their work, and require a 1099 to be sent to them at the end of the year (if paid more than $600/year as of 2022 - although this threshold can change year over year) / whereas an W2 employee is not in control of their scheduled work hours and their services are under the control of their employer (i.e. what & how the work will be done)

  • For a more detailed account of what constitutes an independent contractor, visit the IRS website: https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-defined#:~:text=The%20general%20rule%20is%20that,then%20you%20are%20self%2Demployed.

• You should be requesting tax documents from your employees: A contractor fills out a W9 whereas an employee fills out a W4.

• W2 employees need to have federal, state, and often times local taxes withheld from paychecks (there may also be “local” taxes for where your business is located – a work-in vs a live-in tax), whereas 1099 contractors are paid with no taxes withheld (they are required to pay taxes on all their 1099 earnings come tax time or can make estimated payments throughout the year).

10. Executives/bus owners focusing too much on the “nitty-gritty”

The final mistake I want to mention, which I have faced both as an employee and as a contractor completing accounting services for clients, is an executive/business owner micro-managing their employees/contractors. As an executive, it is your job to run your business and that does mean sometimes that you will need to be a little more involved than you may want to be. However, there is a fine line between being more involved and micro-managing your employees. Spending your time managing your employees’ work with a fine-tooth comb takes away from where you should be spending your time – which is growing your business and generating more revenue. You hired the employees or professionals you have or work with, so trust them to do their jobs – if you don’t then why do you hire them in the first place? Looking over their shoulders, questioning all the work they do, or in general micro-managing their work can lead to a toxic work environment and can cause you to lose great employees. The cost of retention is much lower than the cost of replacement. If you find yourself having trouble trusting your employees, then maybe you need to hire different employees or bring in someone you can trust to manage them appropriately because retaining top talent is the driving force in helping your business succeed.

If you find yourself making any of the mistakes above as a new business owner, if you don’t have an accounting professional helping you with your business, or if you need any help/advice in operating your new small business, feel free to reach out to me as I would love to be of assistance! Good luck to all you new business owners or potential new business owners thinking of going out on their own. Remember to do the proper research and hire the right people to help drive your business to success!

This article was written by Drew DiModica, Accounting Professional and small business owner of Every Penny Accounts.

Contact me!

drew@epaccountsoh.com

(419) 367-6502

www.epaccountsoh.com