Instead of Borrowing from Sales Tax Receipts, and Other Stupid Small Business Killers, this article was originally titled “the Top 5, 10, or 100 Small Business Accounting Mistakes, but after a Google search of the term we reconsidered. There must be nearly 100 articles with nearly the identical title. So much for standing out. So, rather than try to fight for attention, we decided to share the most blatant faux-pas we’ve discovered over the years.
This is not to say that “our clients” were guilty of any of these, it’s just a list of what we believe are the absolute dumbest things small businesses are guilty of on a recurring basis. We work closely with our clients so that these silly things never happen in the first place.
1. “Borrowing” From Sales Tax Receipts – Any business that is required to collect sales tax should open a separate bank account for sales taxes, so they can be forwarded to the proper tax authorities in your town, city, county or state. Leaving it commingled with general revenues is a huge mistake, as they may inadvertently be considered income. Borrowing from the sales tax fund is pure stupidity. Not only do you run the risk of under-reporting or under-filing, you’re sliding down one of the slipperiest of slopes in business. We once heard of a used car dealer in Florida (true story) that would “borrow” money from the sales tax bank account (he was smart enough to establish a separate account, but not smart enough to keep his fingers out of it) and spend it at the local strip club. One thing led to another, and said car dealer lost his license, was heavily fined for not filing the tax in a timely manner, and this activity triggered an IRS audit as well. Some people just can’t win.
2. Not Putting Internal Controls in Place – The risk of fraud is simply too high to not put internal controls in place. Internal financial controls, like segregation of duties happens every time a single person (your cousin Elma or the outsourced bookkeeper) performs multiple functions. Some of these can be depositing the cash, as well as recording sales, cash, sales taxes, credit card and other forms of receipts. Or, consider your business takes inventory every month. The right internal controls is that the inventory should be performed by a dis-interested third party, the calculation of the totals by another, and the recording by still another. Most small businesses simply don’t bother inventorying more than once a year, if at all.
As for fraud from the “bookkeeper, in-house accountant or administrative assistant”, horror stories abound. “I would have never thought that Jane would steal from me,” is a comment often heard.
3. Relying on a bookkeeper to perform tax reporting – First of all, we don’t recommend you use a bookkeeper, or if you must, they only perform batch work to prepare the data for professional review and reporting. If you use an unlicensed or certified accountant to calculate your business’ tax liability you are granting them a (1) license to steal, or (2) inviting the IRS to require an audit. And don’t expect the IRS will recognize the bookkeeper as liable for errors. That falls on the business owner. The Federal tax codes change constantly, with mid-year adjustments to the code occasionally, with annual updates, changes and clarifications. Will a bookkeeper have the wherewithal to stay current on these? Doubtful.
4. Thinking Net Profit Means Cash in Bank – Just because the financial statement and balance sheet reflects a net profit doesn’t have anything to do with how much cash is in the bank accounts. Cash flow calculation is completely different than the reconciliation of the bank accounts. Net profit is calculated simply by income minus all expenses. This is shown on the profit and loss statement for every reporting period. That’s pretty easy to understand.
Cash flow is not as simple as it might sound. Cash in the bank is clearly how much money went in, how much was deducted or moved, and the resulting balance. Cash might be placed in reserve funds, investment vehicles, advance payments or prepaid expenses, all sorts of things.
That’s why it is so important to keep several bank accounts if at all possible, regardless of business size. If you collect sales tax, or have a regular payroll and payroll taxes, it is best to have separate accounts for each of them.
Profits and cash are not the same thing. Your business can show a profit and still go out of business. Working capital is critical to keep things flowing without major hiccups. Cash spends, profits are merely a number on a page and some peace of mind.
5. Ignoring the IRS or Wage & Hour Audit Appointment – Making this mistake is worse than actually going to the appointment without a CPA to represent you and your financial documentation, yet business owners shy away from these stressful meetings or put them out of their minds. A bookkeeper won’t hold any weight on any of these types of meetings; you’d be on your own to explain and defend your actions. Having a CPA not only analyze, record and prepare company financial documentation but also represent and defend your business.
6. Believing Monthly Reconciliation is a Waste of Time – Reconciling the business books and bank accounts are critical processes that ensure proper financial statements. What makes ignoring reconciliation so precarious is that you might under or over-pay taxes, be denied a business loan or worse yet, make commitments you can’t pay for.
7. Making everyone an independent contractor – There are specific penalties when it is determined that independent contractors should have been categorized as employees. In fact, should the Department of Labor determine your business has identified independent contractors that should be employees, you can be liable for years of back employment taxes, penalties and the employee’s AND the employer’s share of social security. The IRS has specific evidence-based categories in order to meet the requirements. Independent contractor qualifications are stringent and encumbering.
You need a professional who is knowledgeable of the requirements.
There’s So Much More
A list of the biggest screw-ups and oversights small business owners make is endless. Think of something, anything that doesn’t make sense, and a small business owner has probably guilty of it. But this isn’t a tirade against small business, quite the contrary. If a single owner gains clear thinking regarding the importance of proper accounting (our shameless plug here), then our goal is achieved. So, without further ado, here are just a few more I found online.
- Not utilizing a tax professional
- Combining business and personal expenses
- Not maintaining an expense receipt file for each financial statement
- Spending personal funds for business and not recording them
- Failing to produce a budget for specific projects
- Not capitalizing large expenditures
- Failing to understand basic accounting principles
- There are more, in fact, they are more or less innumerable.
There are so many things to consider beyond merely Sales Tax Receipts, and Other Stupid Small Business Killers. You must understand and absorb regarding how your business finances are managed, recorded and reported. Every business in this country has responsibilities to their customers, employees, vendors, and stakeholders. They should use the best possible professionals to ensure the sustainability and viability of their business. Utilizing a professional accounting firm can help ensure that.
We’re ready when you are.