Everyone makes mistakes, no matter how diligent they are. It’s all part of being human. According to the Small Business Administration, over half of all small businesses fail within the first five years of opening their doors. The main reasons for this are poor financial management and lack of proper bookkeeping.
The following seven mistakes are among the most common errors that cause small businesses to eventually fail. A few of them may surprise you.
Mistake #1: Combining Business and Personal Finances
One of the golden rules of small business finance is to never combine business finances with personal ones. Before you even open your doors to the public, it’s imperative that you open a business checking account. This ensures that funds taken in by the business are used expressly for business purposes.
The reason for this is twofold. First, it makes bookkeeping much easier if you are not trying to sort business transactions from personal ones. Second, if you intermingle personal and business expenses, it becomes much easier for a lawyer to argue that you should be personally liable for a business mistake. When this happens, your personal assets (like your house or car) could be taken to satisfy a business debt.
Mistake #2: Not Keeping Track of Petty Cash (or Other Cash Accounts)
Many businesses have a “petty cash” account, which is used for small purchases such as office supplies, break room supplies and other incidentals. Other cash accounts can include cash on hand for making change and other cash purchases, checking accounts, money market accounts, and savings accounts.
If you make the mistake of not keeping track of this money, you may end up spending much more than anticipated. You may also find that not everyone is completely honest; keeping track of your accounts helps to mitigate this risk.
Mistake #3: Failing to Reconcile Bank Accounts
You need to reconcile your accounts to be sure there are no errors on either your books or in your bank’s records. Reconciliation is simply the process of comparing your records with your bank’s records. You then adjust your records to reflect bank charges and report any differences you find to the bank.
Don’t panic when it comes time to reconcile your bank accounts each month. Chances are, once you’ve done it once or twice, it will quickly become second nature. Problems arise if and when the task is ignored for several months in a row.
Mistake #4: Neglecting to Save Every Receipt
Some business owners make the mistake of not keeping receipts unless they total more than $75. This is because the IRS requires expenses for things like business travel and meals to be at least that amount to qualify for a deduction. Part of this is a misunderstanding of how total is defined by the IRS: if your receipts for the year total more than $75, you can claim these deductions.
But, more importantly, failure to keep track of every purchase can lead to overspending without you even realizing it. Small purchases can add up quickly if you are not keeping track of them.
Mistake #5: Going Completely Paperless
In today’s world, it’s ridiculously easy to go paperless. Between desktop scanners and smartphone scanning apps, storing your financial records “in the cloud” is simpler than ever. However, when it comes to bookkeeping, you’re much better off leaving a paper trail.
Why? If everything is done by computer and you don’t back up your files, there’s always the possibility that you might lose everything if your hard drive crashes or the online service you are using shuts down for some reason. Also, in the event of an audit, you may be required to bring in original receipts.
Remember, when it comes to keeping track of small business finances, the easiest way isn’t always the best way.
Mistake #6: Misclassifying Employees
Misclassifying employees can be a costly mistake when tax time rolls around. These classifications determine who is eligible for benefits and exactly what benefits you must provide, such as overtime pay and workers’ compensation.
There are two main ways businesses misclassify employees. First, there can be confusion between full-time and part-time employees. Second, there can be confusion between employees and independent contractors.
There are rules regarding the benefits you must provide to full-time employees that often don’t apply to part-time employees. If, however, your part-time employees work more hours than allowed by law, they may be legally entitled to full-time benefits.
A more common problem is using independent contractors to save on payroll taxes. If you are paying someone as an independent contractor, you need to be sure you are not treating them as employees. If the IRS determines that you are treating independent contractors and employees, you could be liable for back payroll taxes.
If you employ anyone, be sure you are classifying them properly and are paying for the benefits and taxes that are required for them. Trying to save money by not providing benefits or paying employees as independent contractors can cost you a lot of money in the long run.
Mistake #7: Doing Your Bookkeeping By Yourself
In an effort to save money, many small business owners attempt to do their own bookkeeping. Even with modern bookkeeping software, it can be very easy to misclassify income and expense. Common mistakes in bookkeeping can double income, overstate expenses, and generally misrepresent the business’ position. This is especially true for those who have had little to no experience or training in bookkeeping.
If your budget doesn’t allow you to hire a bookkeeping employee, even part time, consider contracting with a bookkeeping professional on an “as needed” basis. The money you spend usually comes back to you several times over, considering the possible mistakes a bookkeeping professional will undoubtedly avoid.
The Bottom Line
Now that you’re aware of these common bookkeeping mistakes regarding small business failure, your chance of being successful will likely be much higher. Of course, nothing is guaranteed. But, in this case, knowledge is power. The more you stay on top of your finances, the better off you’ll be.
If you are uncertain about your bookkeeping, or if you need assistance doing your books, schedule a free consultation with Rainbow Bookkeepers today.