The health of your accounting and your books starts with the health of your chart of accounts, which is basically an accounting terminology that refers to a list of categories including income, expenses, and liabilities.
If your business is extremely consistent in how it’s spending money, what it spends money on, and how it receives money, then you can make sound decisions over the course of 90 days. This is data coming out of the accounting system that you can trust. You need to be able to produce quality data because without excellent data and you don't have the facts you need, you can't make the best profit decisions.
At the end of the day, your chart of accounts is something you should absolutely know and understand. In fact, it should be a great training tool you can introduce to your team. It should also be a tool for communication between you and your accountant, your tax pro, or whoever is involved in your finances. So don't underestimate the power of a great chart of accounts.
10 Common Mistakes in Bookkeeping
1. Income
It is very common when we start working with clients for the first time for us to see that they're booking net deposits that enter their bank account as revenue.
They're not necessarily recording sales. For some clients that could really not be an issue because they're collecting a 100% of the payment by check or wire. But if you're using any type of system like Stripe or merchant processing, many times they're making deposits that are net of those processing fees, which means on the net side, you are kind of reflecting the right income.
Sales minus fee equals the deposit. But when it comes to really understanding how much you made in sales, you're not gonna know that, and you're not gonna understand your expenses in terms of how much you paid in order to collect that money. Those are really important things to know.
The merchant processors that we use have to file a 1099K at the end of the year to the IRS. If you're a schedule C follower, it could be that you've got more income that's been reported from your processors than you've actually reported on your tax return.
Those are a bit of the checks and balances that happen between the operations and also the tax process that you're in the middle of. I always tell people to really pay attention to their income, to make sure that a hundred percent of their actual revenue is being reported. If there's anything that's being deducted from that revenue that's it’s being deducted as an expense or a cost, whichever it may be like for Amazon sellers, for example.
We have had plenty of clients we start working where they literally have just booked their deposits from Amazon as revenue. That is a hundred percent not accurate because if you've been around the block and worked on Amazon, any length of time, you know that about 30 to 35% of your sales are gonna be allocated to Amazon for rent and fees and things like that.
When I say rent, I mean, space on the shelf, um, you might have advertising that runs through there. You might have reserved reserves. That's being deducted from there. There's a lot of fees and things that are happening in those Amazon deposits. So if you just record the deposit as revenue, then chances are, you're gonna be grossly under-reporting your revenue, which means you're not going to have the right income come tax time.
And you're really not going to understand truly how your business is operating. So paying attention to income is incredibly important and documenting all sources of that income at its a hundred percent level.
2. Process Fees
Process fees could be third party seller fees, credit card or merchant processing fees, including PayPal. Depending on how you run your finances in your business and PayPal in particular, you might pay people through PayPal. Or you might choose to pay for something through PayPal and post it to the credit card while PayPal's going to charge you a fee in order to do that.
Understanding the difference between the fee and the payment that you made to the person is really important. If you accept PayPal as a form of payment, they're going to charge you a fee for processing that payment. You need to understand those processing fees as well.
Honestly, if you're paying people through PayPal and you're choosing to pay for it on a credit card, then there's gonna be a fee assessed for that. Which is what I would probably call a bank service charge. They’re going to charge you a certain amount of money in order for you to do the transaction.
When you are accepting payments from PayPal, Stripe, Braintree, Shopify payments or a credit card processing or merchant processing fee, understanding your processing fees and deducting these from your sales.
It's really important to understand the gross revenue and then book the fee accordingly, because that's how it also gets reported to the IRS in terms of your income, they're gonna report that gross income.
3. Payroll
Not every business has payroll. Payroll is more common with S-Corp and C-Corp businesses or businesses with W2 employees, regardless of your entity status. It’s common for businesses that are in start up in the first one to three years, like a single member LLC or a sole proprietor, to take what’s called owner’s draw.
This is just a reminder that what you take out of the business in that type of entity is not payroll and doesn’t need to book as wages or to hit your income statement at all, it’s simply just the owner's draw from the business. It has no bearing on your income statement. If you do have payroll and you’re using something like Gusto, which we love at The Bottom Line®, then you’re paying your employees out as W2 wages.
There's a difference in W2 wages for your team and W2 wages that you pay for a shareholder in your business.
If you're a corporation with W2 wages, like an S Corp or a C Corp or an LLC tax as an S Corp, and you've got officers compensation it's really important that you understand what's officer's compensation, what are shareholder wages and what are the other wages essentially related to payroll.
Many times what also happens to payroll is they just want to code the deposit that came out of the bank account to pay the people, including yourself and that's just the net deposit.
That's not reflective of gross wages. There's things that have been deducted from that. And you wanna make sure the wages on your income statement are gonna line up with all the reporting that happens quarterly and annually to your states and the IRS, because those things are cross referenced and checked.
It is very common for us to see people taking the bank deposit and throwing it towards a wages account. Gusto has a nice integration with Xero where it properly reports everything where it should go. If you have a team, it can help you track categories or departments, if you're big enough for that, it can also help you create classes so that you can make sure the owner's compensation for officers goes where it should and the shareholder wages, then all of your other team members.
Payroll tends to be a fairly large expense for any business. And you wanna get it right? There is a lot of material impact to not getting this part right. If you don't get it right throughout the year, I pray that you have a tax pro that pays attention that reconciles your W2s and your annual filings, like your 941s or your 944s to make sure the wages that are represented on your income statement actually match what was reported for the year.
If you do any type of benefits at all for yourself or for your team, making sure that it is being calibrated and accounted for correctly in your wages is also really important.
4. Payroll Tax
Something that is really common is just pushing the net deposit to wages, then if there's another deposit that comes out for tax or you pay the IRS directly for your payroll tax. They'll take that whole amount and push it to payroll tax expense. But here's the deal, that amount is the employer's portion of the payroll tax and it's also the withholding of the employee that got paid for tax and the social security and Medicare. So when you push all of that to payroll tax, it's going to skew how much the business paid an employer tax for payroll tax expense and that's not accurate either. These are the two things around payroll.
I really like for anyone reading to pay attention and also make sure that they're pushing anything as an owner's draw onto those categories for tax or wages. If you're in a sole proprietor or a single member, LLC, there's a lot to know about payroll. So please make sure you're getting the guidance that you need and that anyone supporting you, whether you're a DIYer or doing it with someone or having it done for you, that it's all getting accounted for properly. This is a big deal.
5. Income or Sales Tax
When you make payments on your estimated tax payments, or when you make payments to pay your income tax, that typically is not an expense. Meaning it hits the income statement of the business. You don't want that showing up as a deduction on your income statement because your income tax payments are a personal tax liability and the business is typically providing the funds or resources in the form of a draw or a distribution.
You can pay that personal tax liability federally, because there's no federal tax on any type of entity except for C-Corps. That's not a very common entity. It's really important not to post income tax onto your income statement as an expense and the same goes for sales tax. It's a liability account, meaning you typically collect sales tax for the goods and services you tax things on. You report that at whatever frequency the state is requiring of you. It could be annually, once every six months, once every quarter or once a month.
If you have multiple states, you already know that is happening at different intervals for every state. You don't want to claim sales taxes as an expense. It should be more money in than money out.
When you go to reconcile or balance that liability account, there may be where you've paid in more sales tax than you collected and that would be something you could consider posting on your income statement as an expense, but it's very common for us to see those transactions flow through the account and then all of a sudden they're booking them to expense accounts and it's making you look like you have a lot of expenses when you don't really have legitimate tax deductible expenses.
It's an obligation financially that should have been happening over on your balance sheet, in a liability account or a clearing account. Pay attention when those things post so on income tax, the other thing that I would say is that if you are in a particular type of entity, like ans Corp or an LLC tax as ans Corp or a C Corp, the business could legitimately have tax that it needs to pay to the states and so forth.
When those things are paid, that is absolutely an expense. That's not a liability for you personally, that's a liability of the business in order to operate in that state. So, just be aware of the difference between the two and what that walks and talks like when it comes to your books and accounting.
6. Benefits
Benefits are something else that you need to tend to. So many times we will see people that will book the entire premium for the health insurance, to a health insurance line. When in reality not a hundred percent of that is actually deductible. Depending on the type of entity that you have, and if you have employees or not, you've got to really understand the benefits.
If you're doing anything other than group term life insurance and putting that as a tax deductible expense it's not either can't pay for life insurance through the business and it be deductible, unless it's a group term life policy for you and your employees and that has to be factored properly.
If you're dealing with IRA contributions, like a self-employed pension, a Sep IRA, or if you have a solo 401k, or a 401k in general, the participant contributions and the company contributions are two different things. Making sure you get payroll right, and that it's translating onto the income statement properly, where you're not picking up anything, but the actual expense that you should be is really important.
It's really important to set the foundation of benefit liability and ensure that handling those things is right too. A lot of people just saw it hit the bank and then post the expense to the income statement. Many times it's not even supposed to be on that income statement, which means it's reducing your income, which means you're not gonna file an accurate tax return.
So understand as a percentage of revenue, what you're spending, because there are things that are happening operationally that should not have happened that way. You need to understand those numbers so you really have a good perspective on how the business is doing from an operation standpoint.
Evaluate your income statement and profitability, and then look at how it's looking in terms of how the movement of cash is happening in the business.
7. Owner’s Draw
I mentioned the owner's draw up in payroll, just a reminder, it’s very common to see people, especially in their early days of doing their accounting people are co-mingling. The best practice that they may know or not know about is to not co-mingle in your business. It does happen. It is a reality and it's important that you understand that anything personal that flows through your business, if you're a sole proprietor or a single member, LLC, that is an owner's draw and you need to make sure that it's being pushed there.
Be sure that you're not pushing your Netflix subscription to subscriptions and calling that an expense, unless you have a reason and you believe that it needs to exist in the business. It’s up to you to make that decision and that determination. But any personal expenses that might be flowing through the business would be considered the owner's draw.
Any cash that you pull out of the business that would be considered the owner's draw and those things are not expense items. If you are commingling, I would just encourage you to kind of evaluate your financial processes and try to do what you can using a system like Profit First to determine how much you can and should be paying yourself and transferring that to yourself a few times a month, and then living from your own personal bank account to cover your personal expenses.
Just so you can keep everything in good shape and start rethinking or reimagining your money instead, and break those two things apart to where this is my business and this is me. You've got the processes in place that are supporting that owners' draws are not expenses and that's just really important for you guys to understand.
8. Cash Back Rewards
We love them. We use our credit cards. We try to get as many expenses on those credit cards as we can. Then our rewards, in terms of cash back, are greater. There are two ways that you can handle cash back rewards. I know the preference is to just kind of not report it anywhere.
Just kind of put it off to the side and like that's what you get for basically using the card. And that's a common mistake. There's two ways to really treat it. Number one is you credit back the account that you believe created the reward. Well, that is just tedious and very laborious to figure out.
Out of this, a hundred dollars in cash back rewards this month, I'm gonna allocate a credit back to travel. Meals, whatever the way like to handle it inside our business is we book it as other revenue. So we're treating the cash back rewards as income because it is, and then that way, whatever expenses were allocated to the respective accounts, they're there a hundred percent because those are legitimate expenses.
If you're following all the rules and things like that, they are tax deductible and then you're just claiming that income. So it's a much easier way to approach it, but you do have to treat cash back rewards one of those two ways you can't just call it like an owner's contribution or shareholder's contribution as though you've put money in the business.
It is income or it's a credit against a previous transaction. The simple, practical, powerful way to deal with it is to book it as other revenue or income, and then make sure that your expenses are allocated accordingly and you don't have to offset those.
9. Refunds
It's very common for people to think about refunds related to sales and refunds like I'm getting my money back for something that I paid for. On our chart of accounts, there's a refunds account as a direct cost up in cost of goods and how you handle a refund for sales and how you handle a refund for expenses, or maybe even a reimbursement, if you will, is completely different.
The refund account is how many refunds have we returned to our customer for our sales and I'm surprised by how many people don't actually try to track.
I think tracking refunds and making sure that it's visible on your income statement is pretty important. As a percentage of revenue, you wanna see that and if you're a really high volume business, this percentage 1% could make a difference in the overall profitability of your organization and its utilization of cash.
I think it's just really important to understand but this goes back to reporting your sales and making sure your refunds are being reported properly and making sure your fees are being reported properly. So it kind of has that domino effect that once you address revenue and how it's gonna be reported, you can easily start kind of tackling some of these things around discounts and refunds and, and things of that nature and fees along with.
When you have a refund because you purchased a course or you purchased a computer or what have you, you're basically gonna actually allocate that refund back to the account where the charge was. So if I go out and I buy the latest tiny course because I got sucked in on my Facebook feed and I dropped 37 bucks and I just decide 37 bucks was just too much, which I would never do by the way.
I think people work hard for these tiny products and if I hit the buy button, you're never gonna hear from me again, but to each his own. But let's just say I wanna return it and take advantage of their guarantee, which is no problem. That $37 gets returned to me. I'm gonna return it back to the same training and education account that I posted the expense in, which then means it's a net zero wash.
You could have some overlap if you're on a cash basis. Like if I bought something in December, but I didn't get the return until January. You're not gonna see like a zero in the same year, but you're still offsetting it. So just know that there's a difference between sales as a refund and refunds in terms of expenses.
I would be remiss if I didn't say, if you get reimbursements from clients, I would personally recommend that you have a way to track those things that are supposed to come back to you and that you're not doing it on your income statement. It's more like a liability account or receivables account, if you will, on your balance sheet saying I'm expecting this money to come back. We spent it, but it's gonna be reimbursed by our client. If you don't choose to do that again, it works the same way as a refund.
When you receive the reimbursement for the travel or the meals or whatever you invoice, you need to credit back into that account, or you need to report it as income, which would be a net zero two.
10. Chart of Accounts
I believe wholeheartedly in my whole soul, that the health of your accounting and your book starts with the health of your chart of accounts.
Your chart of accounts is just accounting terminology that's basically a list of categories that income and expenses and liabilities should be bucketed into. These are decisions that you should not have to make over and over and over again. Especially if your business is extremely consistent in how it spends money, what it spends money on and how it receives money.
You can make decisions over the course of 90 days, and then you've pretty much got your process of that decision dialed in. It's consistently being applied and you can really trust and rely on the data that's coming out of your accounting system.
If you have a lot of volatility and how you're spending money, or you're moving from credit card to credit card, this could make bookkeeping more difficult, but at the end of the day, your chart of accounts is something you should absolutely know and understand.
It should be a training tool for your team. It should be a tool for communication between you and your accountant, your tax pro, or whoever is involved in your finances. Don't underestimate the power of a really great chart of accounts. Sometimes people want all these accounts with all these little things applied to it, and that could be like data overload.
Sometimes people just want two or three accounts where pretty much everything's bucketed in there. You really can't understand what's happening in your business, or they'll have things like miscellaneous or general, and they'll just bucket things. Also a big red flag to make sure that you're being as descriptive as you need to be and not doing more than you need to be in order to get the information that you need.
To also make it clear, not only to you, but when it comes time to file your taxes, that it's clear to the IRS on how you spent your money, because they do look and try to pay attention to the percentage that you're spending in relation to your revenue. They're looking for reasonable and customary or usual and customary kinds in that regard.
So you wanna understand how to manage and grow your business and that's just one of the things that they could potentially look at as well. So a great chart of accounts is really the foundation for an amazing set of books.
If you want to learn more about the common bookkeeping mistakes, check out Episode 093: 10 Common Bookkeeping Mistakes You Should Know & Understand.
