Top 10 Accounting Mistakes

Top 10 Accounting Mistakes
The stats aren’t good. According to the U.S. Small Business Administration, for every one hundred new small businesses launched in the U.S., around fifty will go under within the first five years. The primary reason for small-business failure? Poor financial management.
However, there are things you can do to boost your chances of being on the successful side of that statistic. Let’s look at ten ways poor financial managers put themselves in such a position and what you can do differently to avoid them.
1. Using the Wrong Accounting Method
There’s no hard and fast rule as to whether you should choose the cash or accrual accounting method. That decision is dependent on many factors such as size and scale of your business, whether you buy on credit and extend payment terms to your customers, etc. Typically, the cash method should be used only by smaller, sole proprietor businesses, and those that do not hold inventory. This is because there is more likelihood that you are physically receiving money at virtually the same time as you ‘earn’ it, and forking out the cash at the same time that you ‘spend’ it. As your business grows and becomes more sophisticated, it’s usually wise to switch to the accrual-based accounting method. You’ll be able to keep track of what times of the year or month are the most (and least) profitable and base business decisions on that information. You’ll know in advance whether you’ll have enough money to pay all the bills next month. You’ll have an indication throughout the course of the year what your tax situation is likely to be. While there are tax adjustments to be made to convert your accounting profit into taxable income, your profit and loss statement is going to be a much more accurate representation of your business’s financial and tax performance under the accrual method.
2. Mixing Business with Pleasure
Now, of course, you can (and people do) conduct all your personal and business matters through the same checking account. But when it comes to finances, it’s crucial to keep business funds and personal funds well and truly separate. While this division is vital for any-sized businesswhatsoever, it’seven moreimportant ifyour businessoperatesthrough acompanyor otherseparatelegal structure.The first formal step when starting a newventure is to get all the paperwork andlegalities out of the way. The very next step isto open a business checking account to whichall business income is deposited, and allbusiness expenses are deducted.
From here, you should collaborate with your accountant to come up with a strategy to manage the business’s finances, the amount and method that you will ‘pay’ yourself from the business and both short- and long-term savings/expansion/expenditure goals for your business. All of these decisions will be based on your budget, forecasts, cyclical and seasonal influences, your plans for major expenditure to grow the business, as well as your personal financial strategy.
3. Misclassifying Workers
The legal requirements you are obligated to comply with when employing workers differ depending on how those workers are classified. Consider the alternatives:
·         Full-time employees
·         Part-time employees
·         Temporary employees
·         Independent contractors
·         Freelancers
·         Consultants
Getting the classification wrong can be extremely costly because you may be penalized or forced to back-pay the benefits and entitlements that should have applied to your worker. Of the employment categories, in most cases full-time employees are entitled to receive all benefits and part-timers usually receive a proportion of them. Temporary employees and independent contractors don’t receive benefits in most cases, and contractors, freelancers, and consultants generally don’t fall under the minimum wage, overtime, payroll tax, workers’ compensation, and unemployment compensation legislation.
4. Forgetting or Avoiding Basic Account Reconciliations
Bank reconciliations are critical in any business. You absolutely must verify that every transaction that has gone through your bank account (which will be a separate, business-only bank account –see item 2 above) has been recorded in your accounting system for both accountancy purposes, and tax purposes. Undeniably, you must also verify that all income earned and expenses recorded have actually been paid or received. It’s no good making a big profit on paper if you end up with a massive bad debt expense because there’s no one checking up to see that the customers are paying their bills. Finally, it’s imperative to regularly scrutinizeyour accounts and records to identify bankmistakes (hey, they do happen), and your ownor employee errors (or fraud) which can addup very quickly. You often hear news storiesof people stealing thousands, or hundredsof thousands, (or millions!) of dollars frombusiness bank accounts. Although they can’tguarantee your immunity, proper, regularbank reconciliationscan help to identifyand deter suchbehavior.
5. Being Blasé about Petty Cash
Most businesses run with a small amount of cash tucked away for those regular, inexpensive incidentals. Need a bottle of milk for the office? Take it out of petty cash. Run out of postage stamps? Take it out of petty cash. A big mistake that people can make is treating petty cash as if it’s just ‘small change’. That it’s not important to accurately monitor or account for what happens with the money. But just because the monetary value is relatively small, doesn’t mean you can be blasé.
The simplest form of accounting for petty cash is to require any funds removed to be replaced with a receipt identifying the item purchased and the amount. Once the stash starts getting low you can reconcile the receipts with the amount that was originally there, record those expenses in your accounting system, and top-up the stash. The reconciliation will identify if any funds have ‘gone missing’ and what your petty cash is being spent on; another piece of information valuable to a business owner and decision maker.
6. Believing Profits = Cash Flow
Positive cash flow is important. But if you’re not making a profit, positive cash flow can only go on for so long; eventually the bubble will burst and you’ll be in big trouble!
Businesses can quite often operate at a loss while still running with a positive cash flow – at least for the short-term. This tends to happen in businesses that receive payment from their customers but purchase their supplies on credit terms.
On the other hand, if you have to pay your suppliers up-front, but your customers settle their bills with you over a period of time – especially if they’re slow payers – you may appear to have a negative cash flow for a period, even if you’re running at a profit.
In essence, you clearly must have appropriate cash flow to manage your business on a day-to-day basis, but don’t make the mistake of believing that cash flow equals profit. To get an accurate representation of how your business is performing, you’ll need to be using an accruals accounting method and regularly preparing financial statements. A balance sheet and profit and loss statement should be produced at least every quarter, or preferably every month.
7. D-I-Y Accounting
Small business owners often pride themselves on their ability to multitask and handle the many different aspects of a business. A lot of the time this includes the accounting and bookkeeping. However, as with legal or medical issues, it’s really your best bet to seek assistance from a qualified, trained professional, rather than doing it yourself.
Accounting may seem like a simple numerical exercise, but there is extremely technical legislation at all levels which will apply (or not) depending on a multitude of factors. Simply put, a non-specialist is unlikely to be sufficiently trained across every single aspect to do this job. Hiring a trained, qualified accountant, even if it’s only a part-time or consultant position, is well worth the cost. You’ll soon be rewarded in both time saved and the prevention of potential errors.
8. Not Saving Receipts for Small Purchases
Just because the IRS requires you to keep receipts for business travel, meals, and entertainment where the cost is $75 or more, doesn’t mean that anything less than that can be ignored. There are countless businesses who don’t think twice about discarding a receipt for less than $75 – and this can be a huge mistake!
These receipts are indescribably helpful as backup documentary evidence. Not only can they give you peace of mind if you’re subject to an audit, but a policy of keeping and recording every single receipt means that you’ll be sure that you’re claiming every single deduction you’re entitled to. Often, people who throw away receipts are doing the equivalent of throwing away cash that the tax-man wanted to refund to them!
9. Too Much Trust, Not Enough Monitoring
While we all hope that the employees we choose to entrust our business to are ‘good’ people with honorable intentions, a simple look at the world around tells you that isn’t always the case. Even if you truly believe the best of your workers, anyone can have a hidden secret, and personal circumstances or tragedies can alter normally upstanding citizens’ boundaries and actions.
Internal financial controls are the best way to guard against bookkeeper embezzlement and fraud. This is an extremely important issue; businesses that fall victim can go bankrupt!
One of the common checks and balances that should be implemented in a business ofany size is the separation of financial duties. You don’t want any one single person to have access to your funds, as well as access to the means and opportunity to disguise unauthorized access. While fraud can and still does occur even with separation of duties, it is made much more difficult by the fact that two or more people would have to collaborate to get away with it.
If you are too small of a business to have such a division of duties, you yourself should step in and monitor what’s happening on a regular basis, and perhaps conduct unannounced random checks of individual transactions here and there.
10. Going Paperless at the Expense of a Paper Trail
Most of us do our best to reduce the negative impact we humans are having on the planet. Many companies have chosen to go paperless to further this aim. However, when it comes to an audit or investigation into your business finances, there is simply no substitute for a good old paper trail.
While I’m all for doing your best to be environmentally conscious and minimizing your impact on the world around us, you don’t want to do so at the expense of your livelihood. Computer systems crash. Hard drives can be destroyed or damaged. When it comes to bookkeeping, evidentiary receipts, invoices, and other documentation, this is one area where you should err on the side of caution.