As an entrepreneur, you often have a lot of hats to wear when it comes to running your business -- or
at least you often feel as if you have to wear many of them. The truth is that you do not have to be a jack-of-all-trades. You can delegate roles and responsibilities to key personnel within your company or engage professionals outside of your company to handle tasks that you do not have internal staff to perform. You need only understand what these individuals are doing, but you do not necessarily need to know the nitty-gritty details of how they do their jobs. Many entrepreneurs have an overwhelming need to control all aspects of their business, increasing the likelihood of accounting mistakes and errors that could have easily been avoided if they had outsourced those tasks to someone else. You will find three common accounting mistakes entrepreneurs make so you can avoid them yourself in your small business.
Accounting mistake #1: You record deposits for a product or service as revenue.
A common accounting mistake you can make as an enterprising entrepreneur is to record the payment received from a customer for a product or service as revenue. Since you have to return this money to your customer at some point, it is not properly revenue; it is a liability because it represents an amount you owe your customer. If you record this in your sales revenue account and you do not back them out of revenue, then you overstate your company’s revenues for the year and pay income tax on the additional revenue that you could have avoided. You may also lose track of how much deposits you have on hand and what customers paid a deposit. This can be an accounting headache, to say the least, as you will have to go and backtrack through your records to figure out who is owed how much.
Accounting mistake #2: You expense all large equipment purchases.
As an entrepreneur, you may have heard that you have a significant tax advantage because you get to deduct all your business expenses and then pay tax unlike an employee who pays for everything with after-tax dollars. While this statement is generally true, it is not precisely accurate: you have to deduct large equipment purchases, such as cars, computers, and machines, over their useful lives and not expense the entire amount in the year purchases. Now, you may be aware of some exceptions to this rule if you’re familiar with section 179 expenses and bonus depreciation, which you can find more about these capital asset depreciation rules here. (For another good resource on this topic, you can visit www.section179.org.) The shorty story of these large purchases is that you have to record them as assets on your balance sheet, and then you get to offset the cost each year with a charge against that asset known as depreciation expense. The cash goes out the door and the tax benefits come back over a period of time. If you do not keep track of these assets, you will have to do a lot of extra work to prepare your tax return properly. You will also run the risk that you expense capital assets instead of depreciating them and then run into problems if your tax returns are not prepared accurately.
Accounting mistake #3: You mistake profits from cash flow.
Profits and cash flow are two different concepts, which can best be understood by an illustration of an extreme case. As an entrepreneur, let us just say that you are ramping up your business, investing heavily in your future success by purchasing machines and equipment that will make your business run smoothly for years to come. You have $1 million of revenues for the year and $750 thousand of expenses and purchased $245 thousand of machines and equipment to operate your business. You accountant tells you that you did will for the year with a profit of $250 thousand. But you do not feel profitable because when you look at your cash, you have only $5 thousand in the bank. You showed a profit because the equipment you purchased will be expensed over the next several years, but the cash went out the door this year. You showed a profit but had no cash flow due to the purchase of the equipment. This is another common accounting mistake made by entrepreneurs.
Accounting mistake #1: You record deposits for a product or service as revenue.
A common accounting mistake you can make as an enterprising entrepreneur is to record the payment received from a customer for a product or service as revenue. Since you have to return this money to your customer at some point, it is not properly revenue; it is a liability because it represents an amount you owe your customer. If you record this in your sales revenue account and you do not back them out of revenue, then you overstate your company’s revenues for the year and pay income tax on the additional revenue that you could have avoided. You may also lose track of how much deposits you have on hand and what customers paid a deposit. This can be an accounting headache, to say the least, as you will have to go and backtrack through your records to figure out who is owed how much.
Accounting mistake #2: You expense all large equipment purchases.
As an entrepreneur, you may have heard that you have a significant tax advantage because you get to deduct all your business expenses and then pay tax unlike an employee who pays for everything with after-tax dollars. While this statement is generally true, it is not precisely accurate: you have to deduct large equipment purchases, such as cars, computers, and machines, over their useful lives and not expense the entire amount in the year purchases. Now, you may be aware of some exceptions to this rule if you’re familiar with section 179 expenses and bonus depreciation, which you can find more about these capital asset depreciation rules here. (For another good resource on this topic, you can visit www.section179.org.) The shorty story of these large purchases is that you have to record them as assets on your balance sheet, and then you get to offset the cost each year with a charge against that asset known as depreciation expense. The cash goes out the door and the tax benefits come back over a period of time. If you do not keep track of these assets, you will have to do a lot of extra work to prepare your tax return properly. You will also run the risk that you expense capital assets instead of depreciating them and then run into problems if your tax returns are not prepared accurately.
Accounting mistake #3: You mistake profits from cash flow.
Profits and cash flow are two different concepts, which can best be understood by an illustration of an extreme case. As an entrepreneur, let us just say that you are ramping up your business, investing heavily in your future success by purchasing machines and equipment that will make your business run smoothly for years to come. You have $1 million of revenues for the year and $750 thousand of expenses and purchased $245 thousand of machines and equipment to operate your business. You accountant tells you that you did will for the year with a profit of $250 thousand. But you do not feel profitable because when you look at your cash, you have only $5 thousand in the bank. You showed a profit because the equipment you purchased will be expensed over the next several years, but the cash went out the door this year. You showed a profit but had no cash flow due to the purchase of the equipment. This is another common accounting mistake made by entrepreneurs.
