Your best effort to organize your books always falls by the wayside because something more urgent (or more enjoyable) comes along.  As a self-employed, unincorporated, or home business owner, can your business survive a tax audit? Is your record keeping system setup to increase the likelihood of a smooth flowing audit (it will happen eventually)? If you do your own bookkeeping, do you know if you are following good practices? Do you know what common bookkeeping errors to avoid?

If you’re serious about minimizing your business taxes, the first things to do are to clean up your books and get them up to date.  The first place you can save money related to taxes is by not being charged by your tax preparer to sort through a year’s worth of disorganized invoices, bank statements and receipts. Below are five things you can do to avoid paying extra for your tax preparer’s time, and/or to minimize the expense of an audit should this be your unlucky year.

1. Separate Your Business and Personal Finances
Find areas where you’re mixing business and personal finances, something you should always avoid. The temptation to mix your finances is huge, especially given the trend toward more sole proprietorships. The vast majority of businesses are sole proprietorships launched with credit cards, home equity lines of credit, and other personal financial resources. But this is all the more reason to be very disciplined about keeping things separate, as these kinds of companies are among the most commonly targeted for an IRS audit.

When you commingle funds, the true performance of your business quickly becomes hard to pin down. It’s a challenge to establish hard numbers for expenditures and revenues. Your and tax filing becomes more complex (and expensive due to added hours required).

The benefits of keeping clean books include potential tax advantages in the deductions you won’t miss. Keeping clean books can also keep you under the IRS radar, thus avoiding “distracting” audits. Additionally, it just makes good business sense at a strategic level because well-organized books provide clarity about the true performance of your business so you’re better equipped to make important decisions, impress lenders and investors, attract partners, and potentially sell the business for top dollar.

There are many circumstances where you’ll be confronted with choices to make about mixing personal and business finances. For example, you might have to use personal credit to purchase assets, or you might have to move money from a personal account to a business account to cover a shortfall. Perhaps you’ll need some extra cash personally and will want to take that cash out of the business. The key is making sure that you do this in a completely organized and well-documented way to minimize any negative impact.

2. Reconcile Your Bank (and Credit Card) Statements
Reconcile all of your business bank statements through the end of December. Since the review of bank statements is part of any IRS audit, you want to make sure that you don’t miss any transactions that are relevant for the tax year.  

The business checking account in your books contains a record of the transactions (checks written, receipts from customers, etc.) that involve all of the checking account activity. The bank also creates a record of the company’s checking account activity when it processes the company’s checks, deposits, service charges, and other items. Soon after each month ends the bank provides you with a bank statement. This statement lists the activity in the bank account during that month as well as the ending balance. Verify that the amounts on the bank statement are consistent with the amounts in the company’s books and vice versa. This process of confirming the amounts is referred to as reconciling the bank statement. The benefit of reconciling the bank statement is that you need to know that the amount of money reported in your books is the same as the amount shown in the bank’s records.

Because most companies write hundreds of checks each month and make many deposits, reconciling the amounts on the company’s books with the amounts on the bank statement can be time consuming. The process is complicated because some items appear in the company’s checking account in one month, but appear on the bank statement in a different month. For example, checks written near the end of September are deducted immediately on the company’s books, but those checks will most likely not clear the bank account until early October. Sometimes the bank decreases the company’s bank account without informing the company of the amount. For example, a bank service charge might be deducted on the bank statement on September 30th, but the company will not learn of that amount until it receives the bank statement in early September. From these two examples, you can see why there will likely be a difference in the balance on the bank statement vs. the balance in the company’s books. It is also possible (perhaps likely) that neither balance is the true balance. Both balances may need adjustment in order to report the true amount of cash on hand.

After you adjust the balance per bank to be the true balance and after you adjust the balance per books to also be the same true balance, you have reconciled the bank statement. Now do the same for your business credit card statements.

3. Automobile Expenses
Automobile expenses can be a major expense for a small business. You should maintain a log to keep track of where and when business travel occurred, who was seen, and what was the business purpose of the trip. While some individuals only track business use, I recommend keeping the log for all auto expenses, since those who itemize their deductions can also deduct transportation as a medical expense, and as a charitable contribution deduction if active in a charity. The business tax returns will want to know when you placed the vehicle in service, and the amount of the business, commuting and personal miles for each vehicle for the year. And if you are audited, your business travel log will be scrutinized and compared to the business appointments shown in your calendar and other journals you should be keeping. Just keeping a mileage log without notes and explanations will not be acceptable.

4. Non-Employee Compensation
You should review your records on the independent contractors you have paid to see if the government must be notified of their non-employee compensation. Employees receive a W-2 form to identify their income and withholding tax. Similarly, independent contractors who make $600 or more receive form 1099-MISC from you, with the federal and state governments receiving a copy. Contractors who are corporations are exempt from receiving this form, but individuals, partnerships and limited liability companies must receive them. If you wait until year-end to obtain the contractor’s social security number or employer identification number you might not be successful in obtaining that required information. Have your contactors fill out form W-9 to give you the needed information.

5. Check for Inconsistencies, Reasonableness, and Discrepancies
Having your bank statements reconciled and having your financial information up to date, will give you an appropriate starting point to check for general accuracies, or inaccuracies, in your books.

Before sending your information to your tax preparer, perform some type of reasonableness test on your income statement.  If you see something that doesn’t look right there is a good chance that it isn’t.  Make sure to investigate all items that do not meet these tests and ensure that there is a good explanation for each of them.  A common error is to have the same items reported in December and in January.  One method to analyze the books and find errors is to review income statements and other financials on a month to month basis, where inconsistencies are more easily identified.

Finally, run a balance sheet for the last day of the year and compare this against the balance sheet you provided to your tax accountant for your tax return last year. If any account balances have changed from amounts entered on your prior year return, make sure to identify what has changed.  Doing this yourself will save you money since your accountant will charge you to do it as part of your tax preparation.  To minimize tax issues, try to identify discrepancies and bring them to the attention of your tax preparer.

So schedule time on your calendar now to work on these items and decide now what your deadline is to get your books and records ready for tax season. If this process is painful for you, remember that it’s easier to file your business records and update your and bookkeeping system on at least a monthly basis. If you stick to a regular schedule then next year at this time you’ll be ready for tax season.  Then again, your best efforts to organize your books may still fall by the wayside because something more urgent (or more enjoyable) comes along.  If that’s you, contact me as I can take all this pain away, and your books will be clean, accurate, up to date and ready for your tax preparer to spend the least amount of time(and money) on your returns.

Most small businesses owners use QuickBooks for their , but since most are self-taught through trial and error, many are not using the program correctly. Accounting knowledge and the analytical skills to review the financial statements are necessary to ensure accuracy.  The following are eight of the most common errors I see among QuickBooks users:

1. Entering a Bill, then Writing a Check

Accounts Payable should be properly managed by entering each bill as it arrives from the vendor using the Enter Bills window. Then pay the bill in the Pay Bills window. If you enter a bill, and then pay it by using Write Checks, you will record the expense twice, plus you still have an unpaid bill which creates an outstanding accounts payable. If you don’t use the Enter Bill/Pay Bills features and simply use the Write Check feature, then you won’t be able to use QuickBooks to manage your cash-flow and better plan future payments.

2. Incorrectly Posting Money Received from Customers

Similar to writing checks, don’t enter sales invoices and then make a deposit without going through the Receive Payments step.  When you receive a payment, apply it to the appropriate invoice. I see a lot of “messy books” where the people go right to the Make Deposits screen, and so the invoices aren’t shown as being paid.

Don’t accidentally record your customer’s payments twice. When you receive a payment for an invoice and enter it in the Receive Payments window off the Customers menu, QuickBooks automatically puts the money into the Undeposited Funds account. Do not go forth and make a separate deposit for the same amount against the same invoice. Use the Make Deposits windos off the Banking menu to move the payment from the Undeposited Funds account to your bank account.

3. Entering a Credit Card Charge and a Bill for the Same Expense

Do not enter a bill and write a check to your credit card company for your credit card charges. Instead, go to the Banking menu item and select Enter Credit Card Charges. Choose the correct credit card and enter all your charges and any credits/refunds, if you have them, there.

4. Pay Payroll Taxes with the Pay Liabilities Window

When you create paychecks for your employees, use the Pay Liabilities window to pay your payroll taxes. Don’t use the Write Checks window. When you process payroll QuickBooks keeps track of how much payroll tax you owe, and records it in your Payroll Liabilities account. When you use the Pay Liabilities window to pay your payroll tax QuickBooks will decrease the balance of the liability account accordingly.

5. Don’t Use Inventory Accounting Unless You Have To

Try to use non-inventory items for your inventory. Are you required to keep your books on an accrual basis for your taxes? Unless inventory plays a significant role in your business, you may not be required. And, even if you are required, you’re only going to need to know your inventory at the end of the year. Using QuickBooks to keep track of your inventory so you know what you have can be a real bear, so be sure to talk to your accountant. Once you create all your inventory items as Inventory Items, it’s hard to go back and undo the problems that erroneous setups can cause.

6. Associate Inventory Items with the Right Accounts

If you keep inventory, make sure that you assign your inventory items to all the right accounts. Each inventory type item should have three; an Inventory Asset account, a Cost of Goods Sold account, and a Sales account. When you tell QuickBooks that you have inventory, it automatically sets up an Inventory Asset account (to track the current value of your inventory) and a Cost of Goods Sold account (to track how much you paid for your inventory items). You must also set up sales income accounts to track the income you make from selling your inventory items.

Here’s how to check yours:
a. From the List menu, select Reports, and then Items. QuickBooks will display your Item list, detailing each one’s name, description, type, posting account, and price.
b. Verify that each inventory item is associated with all three accounts – Cost of Goods Sold, Inventory Asset, and Income Account.

7. Keep the Chart of Accounts Simple

When you set up QuickBooks for the first time, it will suggest a complex and detailed chart of accounts, typically so detailed that small business owners will often create a new account every time they are confused. Keep it simple, by minimizing your account list as much as possible.

One of the most valuable exercises that I take my clients through, particularly with existing users of QuickBooks, is to thin their account list. I will sit with clients personally and help them figure out from a business management perspective what we/they want to see and then we modify the QuickBooks to accommodate that perspective.

8. Don’t Try to Do it All Yourself

QuickBooks is easy to use, but it will be even easier, and give you more peace of mind, if you work with an accountant.