As a business owner, you may have heard that “numbers don’t lie,” or to find the truth, just follow the money. Proper bookkeeping, defined as the practice of accurately recording and organizing financial transactions, is important to your business if your goal is continued growth, longevity, and success.
Appealing to Lenders, Investors, and the IRS
It’s not just your clients or customers who are party to the financial transactions of your business, but your professional partners, too: your accountant, financial advisors, attorneys, creditors, and investors need to know the truth about your financial situation so that they can deliver the best assistance/guidance/input that you seek.
Knowing what tax credits your business may qualify for, whether liabilities are secured, unsecured, long-term or short-term, when income is earned or deferred, which deductions you can take, and the financial performance of different facets of your business, are essential in helping you improve the day-to-day operations, as well as providing insight into your larger strategic vision. Proper business bookkeeping can lay out this information in the universal language of numbers, so it’s easily communicable to both you and others .
Here’s a list of financial reports that are important to have up-to-date and on-hand:
- Income Statement – This report should tell interested parties how much money your business made in gross sales and out of that amount, how much of the gross sales resulted in gross profit. This report also lists expenses reports net loss or profit for the company, otherwise known as the bottom line.
- Balance Sheet – A balance sheet shows interested parties, at a glance for a particular date, what liabilities (debt and tax) the company owes and what assets (equipment, real estate, cash in the bank) a company has. When liabilities exceed assets, a business is technically defined as insolvent. However, comparing a balance sheet from one year to the next, Companies with too many liabilities and not enough assets may seem insolvent.
- Cash Flow Statement – This report helps you understand the amount of cash, and cash equivalents (think bonds), that are entering and leaving your business over a set period of time. While it is important to understand your income statement and balance sheet, if you cash flow statement continuously shows cash flow, even though you have a positive income, you could find you and your business in serious trouble.
The Protective Paper Trail
Proper bookkeeping creates a chronological paper trail that pieces together a timeline of your business’ financial transactions. This information can be vital in stressful times like an IRS Audit, or during ongoing litigation – and it can often mean the difference between resolving disputes in a quick and straightforward manner, as opposed to a seemingly endless situation. With discipline and consistency, implementing and using proper bookkeeping techniques that focus on accurate recording, coupled with meticulous organizing, allows bookkeeping to become as routine (and reliable) as clockwork.
Here are some tips to create a clear trail:
- Use bookkeeping software to record every transaction. Manually inputting transactions in a spreadsheet or keeping a shoebox of receipts isn’t going to cut it for your business. Make sure to record everything into something like Quickbooks, or Xero.
- Categorize your transactions. Your spending and your sales should be categorized so it’s very clear that the expense or sale was related to your business. This helps you understand where your money is coming from and going to so that you can make tactical and strategic decisions about your business, and help you plan a budget for future years.
- Make thorough notes about expenses, especially meals and entertainment expenses. Excessive spending in these categories is often a red flag for the IRS as the days of the “business lunch” at your desk are long dead. However, if you have a clear record of each transaction or trip, with information reflecting how it is business related, this will make an audit a simpler, less painful process. An example is to jot a quick note on the receipt after lunch with a client where you both went “dutch” indicating who the client was, and if you discussed business. This way you have a contemporaneous note that supports claiming the deduction.
Record Keeping and Reporting
Creating a record and paper trail is only one aspect of proper bookkeeping. Keeping organized files and reviewing your reports regularly is a key element to ensuring the financial health of your business.
Here are a few easy tips to keep you on track:
- Look at your financial reports at least monthly so you understand the financial status of your business.
- If you carry payroll or other high-dollar expenses regularly, prepare a cash flow plan each month to make sure you don’t spend money you need for a future transaction.
- Meet with a CPA, bookkeeper, or other qualified professional to regularly review your books if you’re not confident in your accounting abilities. Financial terms can seem daunting; however, after a few meetings with a qualified professional, you will have a better understanding of how things work together, and your confidence in this arena will grow.
Keep your annual records and reports in a file for at least six years. The IRS can audit up to six years of past tax returns. Generally, auditors will look at the previous three years, but if they find errors in those returns, they may ask to audit an additional three years of history. It’s a safe bet to keep at least six years of financial records, receipts, and books on file. However, keep in mind that if they suspect that a fraudulent return was filed, that you failed to file a return, or that you willfully evaded paying taxes, then all bets are off and they can go back as far as they want. So, while tax avoidance – meaning claiming all legitimate deductions and tax credits – is allowed, tax evasion is not.
Under the Magnifying Glass
Yes, proper bookkeeping is a tedious and time-consuming task. As such, delegating or outsourcing bookkeeping work may be a wise investment of your time and energy while allowing you to focus both on and in your business. However, you need to resist the urge to tune out altogether when it comes to bookkeeping, and commit to reviewing the big picture and fine details with whomever is handling your bookkeeping duties on a regular basis. It’s also wise to periodically review new bookkeeping technology and best practices as your business – and the bookkeeping industry – continue to evolve, so that you can stay ahead of the curve for the success of your business.