All business owners should periodically examine their bookkeeping practices to ensure that their system provides an accurate map of the company’s financial condition instead of just a general idea of its direction. After all, even a lost hiker descending a mountain knows that he’s going down. You can avoid becoming lost by keeping a close eye on these three areas:
Incorrect Revenue Reporting
The first accounting error that can cost you money is the incorrect recording of sales revenue. Businesses often receive money that doesn’t count as sales but may be incorrectly recorded as such. Incorrectly recorded revenue in your financial statements results in an overpayment of income taxes and gives you a false sense of your company’s profitability.
A primary source of the complication is accounting software. Using a computer program for invoicing creates accrual income.
Ask your accountant to explain the difference between accrual-basis and cash-basis financial statements.
Make sure your accounting software is recording revenue at the correct time. Entering money received as payment on a customer account before creating an invoice doesn’t record any sales revenue.
You must create invoices first, with a date preceding the recorded date of customer payment.
By far the biggest cause of inaccurate revenue reporting arises in businesses that take deposits from customers prior to delivering a product or service. Customer deposits are not income until you complete the job.
You need to account separately for customer deposits even if you never make refunds. This is particularly important for companies that build, install or repair anything for which customer deposits are required.
The second common accounting error is failing to understand the financial impact of a large purchase. Just because you buy equipment with cash doesn’t mean you can immediately deduct the full cost. You typically write off the expenditure over time.
Some equipment is eligible for deduction of cost in the year of purchase, but a threshold amount is imposed. Even if you can deduct the entire cost in the purchase year, you are prohibited from doing so to create a tax loss.
Borrowing money to make a large purchase has the same consequences as a cash purchase. You don’t deduct the loan payments as an expense. The only expense is interest. Principal payments comprise the equipment cost that’s written off over time.
The third accounting mistake is confusing profit with cash flow. Some issues related to cash flow are addressed above in the discussion of the first two accounting errors. But beyond these factors is the matter of inventory.
Inventory is not an expense until you sell it, but adding inventory does tie up cash. You need to have just enough product – but not too much – for resale. Track what you’re selling versus what you’re buying for inventory.
To gain a better understanding of this entails translating the amount of inventory on hand into the number of days it takes to sell it. Your accountant can help you calculate this figure.