Accounting is a critical function in any business. Whether you just opened your own restaurant, started your private chef practice or been a veteran in the food service business for several years, the bottom line is that good accounting practices can spell the difference between a successful venture or a failed one. Most entrepreneurs have a passion for their core business, like serving great food, but not for bookkeeping or accounting. Accounting can be quite technical and its principles can be a challenge to understand. Many business owners struggle through several pitfalls and these are the most common:
1. Mixing Personal and Business Finances
One of the first steps to make when starting a business is to open a separate bank account.
This is where you deposit all the revenue from your business and where you keep the funds
to pay all your business’ expenses. Although it is common to be personally funding your
venture in the early stages of the business, these funds should be coursed through the
business account and not paid out directly from or “co-mingled” with your personal
account. Having a separate business account from the get-go is the first disciplined
accounting practice a business owner should make and will make things much easier when
recording the financial activities of the business.
Tip: If you are personally funding the business in the early stages, make easily identifiable deposits to the business account (e.g. $1,000 or $5,000) and pay bills directly from that account. Avoid using your personal credit or debit cards to pay business expenses.
2. Not Knowing the Difference Between Profit and Cash Flow
Profit is what remains from the sales revenue after all the business’ expenses are subtracted. Cash flow, on the other hand, is the money flowing in and out of the business from financial activities, investments and other operations. Most small business owners make the costly mistake of not knowing the difference between the two. It is actually possible for a profitable company to run out of cash. This happens when your business records a sale but does not actually receive or collect the cash associated with it. This poses a problem because you may not have enough cash when you need it, to pay your regular expenses.
Tip: Stay on top of your cash at all times particularly if you have inventory of any kind. Consult an accounting professional to set up a proper cash flow report and update this report regularly. Familiarizing yourself with this report is one of the best things you can do in managing your business.
3. Using the Wrong Accounting Method
There are two types of accounting methods – cash and accrual. Most small businesses, especially when they are starting out, tend to use the cash method, where cash is recorded as it comes in and as it goes out of the bank account. It is also the simplest method. Typically, this method is appropriate for simple service businesses that are sole proprietorships and have no inventory. But as the business grows, the method used should shift to accrual accounting. This is where income and expenses are recorded as they occur, regardless of whether there was an actual exchange of cash. Using the accrual method would allow the business owner to accurately match revenue to expenses in the given time period. This will make the financial information more meaningful and give a clearer picture of the business’ financial performance.
4. Not Paying for Themselves
Most small business owners make the crucial mistake of not paying themselves a salary from their own business. This is a critical mistake and related to mistake number one above. Remember that your business is a separate entity from yourself. You, the business owner is different from you, the worker in your business. Regardless of whatever job you do in your business, you must assign a monetary value to it and compensate yourself as part of the business’ normal operating expenses. Paying yourself a reasonable wage is important because it is a true cost of running a business. If you are not around to run your business, someone else will need to do it for you, and they won’t work for free. Furthermore, you want to understand how much it really costs to operate your business. Not compensating yourself or assigning a value to your work artificially inflates your business’ performance by showing a greater profit margin than reality. Now what if there isn’t enough cash flow to cover your salary? The next best thing to do is accrue the amount ech month and make sure it is reflected in your accounting records. That way, when you analyze your business, the reports accurately reflect the true cost of operations.
5. Not Keeping Good Records
Given the many hats they wear, small business owners are often unable to keep up with the tedious task of record keeping. Bills, receipts, statements – they can all be overwhelming and managing them is often a low priority. Nowadays, there are a variety of devices (scanners, camera phones, etc.), online tools and mobile applications that can make this process much more efficient. The IRS now allows for electronic records provided they are organized and accessible. However, there is no escaping the fact that record keeping requires discipline no matter what your preferred method of handling them might be. It’s important to review and organize your financial records for several reasons: First, it is a business tax payer requirement. Next, you want to know the details of your expenses so that they can accurately be tracked in your accounting system. Finally, you want to watch out for any erroneous or fraudulent transactions.
Tip: Make record keeping a habit, just like brushing your teeth. Experiment with different tools and find a method you can adapt. Using a camera phone with a mobile app like Expensify to snap and file photos of your receipts (and tossing them away after) is becoming more and more popular.
6. Using the DIY Method
Enterprising business owners have a “can do” attitude – an important ingredient in starting a business. As entrepreneurs, their passion can be limitless and they often try to wear as many hats as they can, including the accounting hat. However, accounting is a technical and complex practice that small business owners are often better off delegating to the professionals. The investment in working with a qualified accountant will return many times over in the form of time saved, minimizing stress and avoiding costly interest and tax penalties.
Tip: As a business owner, your time is the most valuable one in the business and your business needs your full attention for it to grow. Outsource duties that are outside of your core business, typically the back office (HR, accounting, payroll, taxes) and focus on nurturing your business where it matters the most.
Running your own business is an exciting and hopefully, rewarding endeavor. In order for a business to be successful, the bookkeeping and accounting function should always be in order. Accounting is an important part of your business but it doesn’t have to be stressful if you know how to avoid the common pitfalls.
Vertaccount is an accounting and bookkeeping services provider catering to small and medium size businesses. Our mission is to empower our clients to make informed decisions, thus becoming a real contributor to their success. We aim to be our client’s indispensable partner as we add value to their lives and to their business. Trusted by over 200 clients, processing over 12,000 bills annually and managing over $70 million in revenues, we take a personal approach to your business and assist in all aspects of your financial management.