5 Fatal Accounting Mistakes Small Businesses Make
Going into business can be an exciting venture. Unfortunately, statistics tell us that small business failure is all too common. Half of all new businesses fail within their first five years. Inadequate management is one of the biggest reasons for these failures. Specifically, a lack of financial accountability can doom your business from the beginning. Being a talented craftsman or a gifted marketer does not automatically make a knowledgeable business person. Accounting is no picnic; it can make or break your business. Here are five of the most common mistakes most small businesses make in their accounting activities.
1. Confusing Profits and Cash Flow
It’s easy to confuse these two. It’s easy to assume that if you’re profitable you’ll have enough cash to run your business. But this just isn’t true. And if you have a positive cash flow, that doesn’t necessarily mean that you’re profitable! It can all get quite confusing unless you maintain good accounting records and understand how to read financial statements. As non-accountants, most business owners assume that an expense means money spent. But in accounting, money you spend on capital equipment, loan repayments, and payments to the owner are NOT considered expenses and do NOT impact profit. They simply don’t show up on your Profit and Loss Statement. So it’s easy to be profitable, but have a negative cash flow if you’re spending money to pay off loans or invest in equipment. And if you’re borrowing or investing money, it’s easy to have a positive cash flow, but not be profitable. The relationship between profit and cash flow becomes even harder to understand when you run your financial statements on the Accrual basis, which essentially means that sales and expenses appear on your profit and loss, even if you haven’t received or paid any money. But don’t despair. When you accurately account for all business transactions, your reports will shine a light on where you stand in terms of profit and cash flow. This is essential for companies to know– especially small, vulnerable businesses.
2. Not Reconciling Your Accounts
It can be tedious to locate and account for every cent that passes through business, but to be in control of your finances; it’s a necessity. Every purchase and every sale must be accurately accounted for, which is relatively easy to accomplish. Business owners have many processing options for payments and purchases. Bank accounts, business credit cards, and online accounts such as PayPal are used to collect payments and disburse funds for expenses. But here’s the key, your accounting records for these accounts must match the bank’s records EXACTLY. The bank or institution’s records represent the ultimate source of truth about money flowing in and out of the account. And if your records don’t match, then your accounting and reports won’t be accurate. That’s why you should reconcile your accounting records against monthly statements your bank provides. Failing to resolve any discrepancies leads to inaccurate reports and accounting data that you just can’t trust in the long run.
3. Mixing Business and Personal Finances
Every business needs a bank account, cash supply, and accounting system. Any funds you personally put in or take out must be properly documented in your business accounting. Always keep your personal finances in a separate account from your business transactions, and only take money out as documented pay or a permitted withdrawal. Having a separate business account that is independent of personal accounts is essential for tax deductions, business financing, and reduces the likelihood of penalties in case of an IRS audit. Blurring the lines between business and personal finances will make accurate accounting impossible, and make you and your business financially vulnerable.
4. Forgetting to Record Small Transactions
A general rule in business is that if you watch your pennies, the dollars will take care of themselves. Every transaction, even the smallest ones, must be documented. The best solution is to get a receipt for every purchase, even for purchases made from petty cash. Make notes on the back of the receipts to clarify the purchase details so it can be properly entered into your accounting system, and determine locations to store the receipts before and after they are entered. If you establish policies for your accounting, it will help streamline the processes and keep you on top of your financial condition.
5. Not Understanding Your Accounting Software
Accounting is a complex process. To have a chance at success, most business operators will either need to hire a professional accountant to handle their finances or invest in some business software that can provide clear, concise in-house accounting. A professional accountant can be very expensive, so most owners choose a software option such as QuickBooks to account for their finances instead.
Since accounting is a complicated and precise process, learning to use the software can be an ongoing challenge. QuickBooks is a powerful, full-featured accounting package, designed for any type of business. Training courses are available that will enable you to understand and utilize all the features of the software fully, and not get tripped up by common mistakes. Real World Training is a company endorsed by Intuit, the makers of QuickBooks, that offer QuickBooks training courses to help you understand and maximize the utility of this powerful business tool. If you plan to tackle your small business’ accounting, you’ll save time, avoid confusion, and be confident that you’re maximizing the value you get from QuickBooks if you invest in training.
Your business does not have to be one of the statistics of failure. Instead, you can make your business dreams come true and achieve prosperity like many others. A well-planned system of accounting is a vital step in success. Don’t come up short in analyzing your financial condition, so you can avoid the pitfalls that snare so many along the way. Decide your accounting direction ahead of time, obtain all the training you need, and guide your business with the confidence and knowledge necessary for success.