Small business accounting mistakes will happen. Even the biggest corporations aren’t immune.
Take Uber. Back in 2017, they admitted that they’d been calculating driver payments incorrectly, failing to deduct taxes and fees before applying their commission—the result was a $50M bill payable to the company’s force of contractors.
That’s just one example of why we, as business owners, need to do everything possible to prevent mistakes.
These are the five most common accounting mistakes I come across:
- Overstating revenue
- Mixing up business and personal expenses
- Misclassifying expenses
- Careless record-keeping
- Not checking invoices and accounts receivable
In this article, I’ll explain why these errors happen, what the consequences are, and how you can prevent them.
A mistake is different from an error.
“Error” is a technical term similar to a “fault” or “malfunction.” It’s often used to refer to incongruity between systems. For example, if a piece of software encounters an error, that does not mean the person who wrote the code for the software made a mistake. It points to a problem of communication. Your computer is making sense. The software is making sense. But there’s an interloper between them. (Sounds like a process, doesn’t it?)
That’s not the same as an accounting mistake. A mistake requires human intervention and results from miscommunication or misinterpretation in the world. The real word, of course, matters most.
Small business accounting mistakes are easy to make and difficult to deal with.
1. Avoid overreporting revenue.
Overstating revenue happens because of incomplete revenue recognition processes or gaps in checks and balances.
Let’s say you own a retailer that sells gift cards. You might overstate your revenue by counting the full amount from sold cards as current sales, even though your actual revenue shouldn’t be counted until the cards get spent.
The consequences of revenue gaffs are serious.
There’s a big consequence here: Overstating revenue causes you to pay more taxes than necessary. It could also trigger an audit from the IRS, which obviously carries the risk of major penalties.
2. Immediately cease co-mingling of business and personal finances.
Federal and state governments provide business owners with ample opportunity to pursue their ventures aggressively, free from personal liability for debt and civil torts. A person may file articles of incorporation to become a single-member limited liability company (LLC), and business partners may do the same as a multi-member LLC, taking advantage of the benefits of a partnership and corporation.
There should be exactly zero sole proprietors in the United States. In other words, it is an accounting mistake, a tax mistake, and a legal mistake to give the Internal Revenue Service (IRS) or a court of law any pretense in which they might argue that your personal and business finances are the same.
If you are currently operating a business as an individual, I recommend incorporating. You’ll need those documents to create a business bank account. I have written an article on the benefits of a business bank account for accounting, tax, and loan eligibility.
It’s a great way to get a letter from the IRS.
Mixing personal and business expenses is an easy way to attract the attention of the IRS. Otherwise, it’s a mistake of basic bookkeeping and GAAP principles. The good news is it’s easy to fix.
3. Misclassifying expenses can be construed as fraudulent come tax season.
The distinction between categories can be blurry, leading to mistakes. For example, you might categorize a capital expenditure, like a major Internet Technology (IT) upgrade, as an operating cost, which would then lead to inaccurate tax reporting.
Use reliable accounting software and maintain consistent documentation to prevent classification errors and improve reporting accuracy.
The consequences need to include a deduction and amending your tax return.
If you misclassify an expense, you may end up taking a deduction you’re not entitled to, causing penalties. A misclassification also compromises your financial statements, so you can’t assess the true state of your business.
4. Avoid lax record-keeping.
You need a solid accounting system that includes a paper trail. Even if you have technology that allows you to capture and track receipts, you’ll want a hard-copy backup. You don’t want a technical issue like data loss to be the difference between claiming a deduction or not.
You pay more in taxes.
Poor record-keeping increases the risk of missed deductions, leading to higher tax bills. It can also cause issues during audits, as complete records make it easier to prove compliance, while incomplete records certainly do not.
5. Not checking invoices and accounts receivable.
Keep up with the money you’re owed. If you have an employee generating invoices, know there’s a chance they’ll make errors during busy times (or even commit fraud), which can lead to you not collecting funds.
Similarly, you need to monitor accounts receivable for upcoming payments. Without clear processes, payments can be delivered late, straining relationships with suppliers.
The consequences are simple: businesses lose money and momentum.
Neglecting accounts receivable and invoices leads to missed revenue. Cash flow shortages have the potential to disrupt everyday operations, which can cascade into declining revenue. We see a loss of momentum. We see opportunities that are beyond reach.
Fortunately, all this doom and gloom is preventable. I’m just looking to drive the point home here.
Work with a CPA to create strong processes.
Mistakes happen. Give me a call, and let’s get your processes airtight.
Talk soon,
Jeremy A. Johnson, CPA