Is Your Business Wasting Money with Payroll Errors?

It seems that many business owners could be wasting money because of bookkeeping errors relating to payroll.

The thing is that taxes you pay that are associated with payroll are not your payroll tax expense, and if your bookkeeping records show that they are, your accountant has to fix the error. That’s not an easy task, considering how many pay periods there are in an entire year. This inevitably leads accountants to make a “reasonable” determination about your actual payroll expenses in order to prepare your income tax return. This results in higher costs and missed tax deductions.

Payroll Tax Explained

Your payroll tax expense does not include the taxes withheld from employee pay. That is wages expense. The employees pay the deducted taxes. You simply withhold them and remit them to the Internal Revenue Service (IRS) for the employees.

Your quarterly payroll reports reflect this. Remember, the IRS receives a quarterly payroll tax report with this information. It also obtains your annual income tax return. The IRS compares details from both sources. The wages stated on the quarterly reports must match your income tax return. If they do not match, you are likely to receive a notice from the IRS requesting an explanation. A reply requires time and is costly.

Your quarterly payroll reports to the IRS should also match your annual filing of employee W-2s. If you decide to pay some bonuses at year-end, they must be reported on both the W-2s and the fourth-quarter payroll report to the IRS.

How Your Accountant Can Save You Money

Your accountant helps you by ensuring that deductible wages on your tax return equal wages on the W-2s. If your bookkeeping does not show the exact total on the W-2s as your deductible wages, your accountant does an important exercise. The amount your books show as wages is added to the amount indicated as payroll taxes. The accurate amount of wages – known from the W-2s or quarterly payroll reports – is then subtracted. The remainder must be the payroll taxes. If that figure is not reasonable, more time and cost are involved to determine the error.

To avoid the time delay and cost for locating errors, minor inaccuracies are often ignored. This is a disadvantage to businesses with inaccurate records, because discrepancies are simply lost tax deductions. The cause is normally failure to record in the bookkeeping payroll those taxes that have accrued at year-end. Cash basis accounting records expenses, except for payroll taxes,  when they are paid. The taxes are deductible expenses for the year that the wages are paid. So the payroll taxes you incur for payroll dates this year are tax-deductible this year – even if the taxes are remitted next January. Likewise, the payroll taxes remitted in January of this year relating to wages paid last year should not be recorded in your bookkeeping as current year expenses. Those are last year’s expenses.

You cannot rely on your accounting software to eliminate the possibility of error. Your accountant should help you correctly set up the automated system. Have your payroll accounting reviewed by your accountant at least one other time during the year in addition to tax preparation season. Make sure your payroll reports match your bookkeeping to avoid costly problems and missed tax deductions.

Payroll Taxes: What Business Owners Need to Know

As an employer, you are required by law to withhold money from employees’ pay and remit the amounts to various agencies. In addition, you have direct liability for certain taxes based on workers’ wages.

The taxes that you’re required to withhold on behalf of workers and those that you must pay directly comprise your payroll taxes. Statutory payroll taxes include federal, state and local income taxes, Social Security and Medicare taxes, federal and state unemployment taxes, and, in some states, disability insurance taxes.

Generally speaking, an employee’s gross pay (pay rate times number of hours worked) minus all statutory payroll tax deductions minus voluntary payroll deductions equals net pay. Statutory payroll tax deductions include the following:

•    Federal income tax withholding (based on withholding tables in Publication 15)

•    Social Security tax withholding (6.2% up to the annual maximum)

•    Medicare tax withholding (1.45%)

•    State income tax withholding

•    Various local tax withholdings such as city, count, or school district taxes; state disability; or unemployment insurance

If an employee chooses to participate in certain benefit programs, belong to a professional organization or make designated charitable contributions, these voluntary payroll deductions may also be withheld. Voluntary payroll deductions can include such things as health and life insurance premiums and retirement plan contributions. Voluntary deductions may be paid with pretax dollars or after-tax dollars, depending on the type of designation.

Your responsibility for payroll taxes continues even after paychecks have been issued to employees since you must pay the employer’s share of payroll taxes, deposit the money that has been withheld from workers’ paychecks, prepare various reconciliation reports, account for the payroll expense through financial reporting and file payroll tax returns.

An employer’s portion of payroll taxes is an added expense over and above the expense of an employee’s gross pay. The employer portion of payroll taxes includes the following:

  • Social Security taxes (6.2% up to the annual maximum)
  • Medicare taxes (1.45% of wages)
  • Federal unemployment taxes
  • State unemployment taxes

The Federal Insurance Contributions Act (FICA) tax consists of Social Security and Medicare taxes, which are split 50/50 between the employer and employee. Together the two halves of the FICA taxes add up to 15.3%. The 15.3% FICA tax is broken down as follows:

  • Social Security (employee pays 6.2% and employer pays 6.2%)
  • Medicare (employee pays 1.45% and employer pays 1.45%)

Employers are required to report their payroll tax obligations and to deposit payroll taxes in a timely manner. The key to controlling your payroll tax obligations is making all payments on time, so you avoid getting hit with costly fines and penalties.

Which Bookkeeping System Is the Best for You?

It’s important to find the right system to handle your bookkeeping, bill paying and accounting tasks. Depending on the size and complexity of your business, your needs may vary from simple bookkeeping and bill paying to a more full-featured accounting solution.

To clarify your needs, identify the processes you undertake or expect to undertake in the future. Next, assess the functionality you need. In addition to basic recording and statement reconciliation, you might require such things as data import and export, electronic banking or payroll administration. Exercise due diligence and give careful thought to the following aspects of the system you select:

Management Reports: Choose a system that can quickly and easily provide you with the information that is essential to running your business. Some can create only predefined management reports, while others offer flexibility and allow for customization.

On-Premise or On-Demand Delivery: An online approach offers accessibility, scalability, fixed cost, low maintenance and easy go-live, but issues such as information security and privacy must also be factored in.

Total Cost: Pay attention to the fine print and don’t forget about maintenance, upgrades, service and support costs.

Safety, Security and Data Backup: Check out the backup provisions that are in place. How often do backups occur? What business continuity plans are in place?

Long-Term Viability: Look for a reputable product and a reliable supplier who will be there for the duration.

Ways to Protect Your Business From Internal Fraud

There’s a principle in fraud prevention circles known as the 10-10-80 rule. According to the rule, 10% of employees will not steal under any circumstances, 10% will steal at any opportunity and 80% of employees will steal if they can rationalize the act.

Small businesses are especially vulnerable to employee fraud and theft, and they are often less able than big corporations to absorb such losses.

The first step to preventing employee fraud is to screen job applicants carefully. Before hiring a new worker, you should conduct a thorough background review that includes a criminal history check and drivers abstract scan as well as verification of education and credentials, past employment and reasons for leaving, and references.

Consider running a credit check on prospective employees, especially those who will handle money or deal with financial matters. To obtain a credit report, you are legally required to notify job applicants in writing and to obtain their written consent.

In addition to screening employees, always follow these basic accounting controls:

•    Never allow your business finances to be handled exclusively by a single individual.

•    No employee should be responsible for both recording and processing transactions.

•    Don’t allow the person who sends out bills to collect the mail and prepare bank deposits.

•    Reconcile bank statements at least once a month and conduct random audits or have an outside auditor review your books periodically.

•    Make sure all checks, purchase orders and invoices are consecutively numbered.

•    Mark incoming checks “for deposit only” so they cannot be cashed.

•    Require all checks above a specified amount to have two signatures.

•    Never sign a blank check.

•    Sign every payroll check personally.

•    Avoid using a signature stamp.

Follow up personally if a customer says that they have not received credit for a payment.

Open bank statements and examine canceled checks carefully for red-flag items such as missing check numbers. Look at the checks that have been issued, to make sure the payees are legitimate and signatures are valid.

Review accounts payable by checking cash disbursements and payments.

Finally, be clear with employees that your company has zero tolerance for fraud or theft of any sort. Write and distribute a company policy that spells out what constitutes fraud and specifies the consequences. By establishing internal controls and letting employees know that you are vigilantly looking out for fraud, you can prevent many of your employees from committing fraud.

In addition, a positive work environment has been shown to help deter employee fraud. Open lines of communication and fair employment practices will also go a long way in helping to reduce the problem.

How to Read Your Profit and Loss Statement

A profit and loss statement (P&L) summarizes your business’s revenues and expenses over a given period of time – usually a quarter or fiscal year.

A basic P&L lists net revenue at the top, along with primary income sources such as delivering or producing goods, rendering services, or other activities that constitute ongoing operations. Income from sources other than primary business operations, such as rental income, patents or sales of fixed assets, is itemized separately.

The revenue section is followed by various categories of expenses. Operating expenses can include:

•    General and administrative expenses such as management salaries, legal and professional fees, utilities, insurance, depreciation of buildings and equipment, rent, and supplies

•    Selling expenses such as sales salaries, commissions, travel expenses, advertising, freight and shipping

•    Production-related expenses such as raw materials, equipment maintenance and repair, and labor

•    Depreciation for fixed assets that have been capitalized on the balance sheet

Nonoperating expenses are costs that are not related to primary business operations. Irregular items are generally unusual and nonrecurring. They are reported net of taxes.

What’s left at the end – the bottom line – is your company’s net income or profit.

How to Put Together a Simple Cash Flow Budget

As a small-business owner, it’s up to you to make sure your company has the financial wherewithal to stay afloat, the resources to achieve your business goals and the reserves to fund growth – next week, next month and next year. This requires planning, analysis and a good cash flow budget.

A cash flow budget, also known as a cash flow forecast, is essential to a business’ near-term financial processes and long-term survival. A cash flow budget can help you:

•    Time expenditures based on projected revenues

•    Ensure that you have the cash to pay all your obligations

•    Be proactive about growth and expansion

•    Maintain control of your financial situation

A cash flow budget doesn’t have to be complicated. You can use a simple spreadsheet, purchase budgeting software or even create a forecast by hand. Following are the steps to developing a basic cash flow budget:

•    Determine your projected revenue based on monthly sales or billings.

•    Estimate when you can reasonably expect to collect accounts receivable (AR).

•    Identify any additional expected cash inflows, such as loans, refunds, deposits, etc.

•    Compile all your expenses and other payables.

•    Estimate payment dates for your payables.

•    Add the amounts to your cash disbursements forecast.

You should not include noncash items in your cash flow budget. Although noncash items such as depreciation and amortization are relevant to your financial condition, they do not involve cash outlays and so are not part of the cash flow budget.

Use prior years’ experience and realistic AR estimates as a basis for timing your payables. Items such as payroll, rent and utilities are relatively fixed and recur regularly. Expenses such as advertising, travel and entertainment are somewhat variable but are usually paid in the current budget month. Be sure to figure in fixed asset purchases and loan repayments that you will make during the year.

Once you have created a preliminary cash flow budget, compare your actual results with your budget forecast and note any significant variances. Compare your outstanding AR and accounts payable (AP), focusing on those AR that you expect to collect and AP that you expect to pay in the month ahead. Does the difference between the two equal the amount in your cash flow budget? Are you comfortable with the amount, given your current and future cash position?

Think of the cash flow budget as a living document, and update your budget forecast to reflect new information, such as macroeconomic factors, microeconomic trends or new business activities that will likely impact your business and cash flow.

Use the cash flow forecast as a basis for timing capital expenditures and making expansion and hiring decisions. Also be sure to review the AR list weekly against your projections. Throughout the month, try to make payments within your budget so that you stay close to your planned net cash flow position.

Three Reasons You Need a Good Bookkeeper

For a solopreneur, entrepreneur or small-business owner, having a good bookkeeper is just as important as having a good accountant. One is no substitute for the other.

Generally, a bookkeeper is responsible for recording financial transactions, including sales, purchases, receipts and payments, into a general ledger. Other bookkeeping tasks may include monitoring cash flow, paying bills and collecting money that is due to the company.

Why would you need a bookkeeper? Following are three good reasons:

Time Is Money: Running a business involves a good deal of paperwork, and doing paperwork is probably not the best use of your time. The time you spend doing your own books could almost certainly be better spent.

Accurate Financial Statements: Lenders, investors and creditors expect you to maintain accurate books and produce proper financial statements. These records can also help your business stand up to a tax audit. Of course, you must produce proper financial statements if you ever want to sell your business as well.

Tax and Financial Strategies: A bookkeeper can guard against over- or underpayment of taxes, advise you on the profitability of your efforts, and help you be proactive about your finances.

In the U.S., there is no certification or license requirement for bookkeepers, but the National Association of Certified Public Bookkeepers offers a Certified Bookkeeper credential or Certified Public Bookkeeper license.

How Small Businesses Can Improve Their Cash Flow

It’s a common lament among small-business owners and solopreneurs: “If I’m making so much money, why am I always broke?”

The problem often boils down to the difference between net income and cash flow.

Net income is the bottom line, or the profit or loss that is recorded on your income statement after accounting for all business costs and expenses.

Cash flow is money that has been collected and is available for you to use.

The income statement is updated whenever you make a sale or complete a job.

However, you may not see payment for these activities for 30, 60 or even 90 days. Even though you have generated revenue, it is not yet available as cash for you to spend.

A drastic imbalance between net income and cash flow can lead to a situation where you are generating healthy profits from your business activities, but you don’t have enough cash to cover expenses such as overhead, labor and materials.

The money has been earned and recorded, but it hasn’t been collected and thus is not available to support your operations.

There are a number of ways that cash can get trapped on the balance sheet.

The two most common are for customers to delay payment on receivables and for inventory levels to get out of hand. Here are some ways you can avoid falling victim to your sales success by running out of cash:

  • Monitor cash flow regularly. Get into the habit of staying on top of the amount of money you have available at all times.
  • If your cash flow level falls below a certain threshold, or if you see an adverse trend developing, look into financing options before things reach a crisis point.
  • Use payment policies that enhance cash flow services. Ask customers to make deposits on their orders. Offer discounts to those who pay up front, or use a tiered payment schedule that encourages early payment or pre-payment for goods.
  • Take advantage of your creditors’ payment terms so that you retain use of your cash for as long as possible.
  • Ask suppliers for flexible payment terms as these can be more beneficial to cash flow than discounts or low prices.
  • Avoid keeping excess inventory on hand. Use a just-in-time inventory management system, buying what you need only when you need it.
  • Issue invoices promptly and follow up on payments that are past due.

There are many examples of good, solid companies that failed because they could not generate enough cash.

Cash flow is a better metric of a company’s financial health than net income.

Indeed, operating cash flow is the lifeblood of a company and the most important barometer that lenders and investors use to measure a firm’s financial health.

Your cash flow statement provides immediate insight into your financial position at any point in time and reflects your ability to remain solvent in the near term.

What You Need to Know About Depreciation

Depreciation is an income tax deduction that lets you recover the cost of certain property. To qualify as a depreciation deduction, property must meet the following criteria:

  • You must own the property.
  • You must use the property in business or in an income-producing activity.
  • The property must have a useful life of more than one year.

Most types of tangible property and equipment are depreciable except for land. In addition, some intangible property, such as patents and copyrights, can be depreciated. You may also depreciate the cost of capital improvements on leased property.

Depreciation begins when you place the property in service for your business and ends when you have fully recovered the property’s cost or when it is retired from service, whichever happens first. If you use the property for both business and personal purposes, you can deduct depreciation based only on your business use of the property.

IRS Form 4562, Depreciation and Amortization, is the form used to report depreciation on your tax return.

Straight-line depreciation is the most common method of depreciating assets. However, in order to reduce tax liability as soon as possible, some accountants use other approved methods to accelerate depreciation and record larger amounts of depreciation in the early years of an asset’s life. Check the regulations published by the Internal Revenue Service and your state taxing authority for specific rules regarding depreciation and methods of calculating depreciation for various types of assets.

Confused About Accounting Terms? Here’s a Primer

The following is a glossary of some commonly used accounting and bookkeeping terms:

Accruals: Charges that are incurred and increase even though an invoice has not been received. An example is interest that accrues before you receive a bank statement.

Amortization: The depreciation of an intangible asset such as a loan or mortgage over a fixed period of time.

Burn Rate: The rate at which a company spends money.

Capital: An amount of money put into a business.

Credit: A column in a journal or ledger to record the “from” side of a transaction.

Cost of Goods Sold: A formula for determining the direct cost of merchandise sold over a given period.

Days Sales Outstanding: The average number of days it takes to collect money owed.

Debit: A column in a journal or ledger to record the “to” side of a transaction.

EBIT: Earnings before interest and taxes are deducted.

EBITDA: Earnings before interest, taxes, depreciation and amortization are deducted.

Equity: The net value of a business, calculated by subtracting liabilities from assets.

FIFO: This means first in, first out. It is a method of valuing inventory.

Fiscal Year: A business’s accounting year. It can begin at any point during the calendar year.

Gross Margin: The percentage difference between the selling price of a product or service and the cost of producing that product or service.

Income Statement: A report that summarizes all income and expense accounts and is used to calculate the net income/loss reported on the balance sheet.

Liabilities: Amounts owed to others outside the business.

LIFO: This means last in, first out. It is a method of valuing inventory.

Normalize: This term can be applied to many aspects of accounting. It means to average or smooth out a set of figures so they are more consistent with the general trend of the business.

Profit and Loss Account (P&L): An account composed of revenue and expense accounts. The P&L shows the current profit or loss of the business.

Profit Margin: The percentage difference between the cost of a product and the amount it sells for.

ProForma Financial Statements: Financial statements that have not been officially audited.

Retained Earnings: The amount of money held in a business after the owners have taken their share of profits.

Revenue: The sales and any other taxable income from all sources including sales.

Run Rate: An annual forecast based on current year-to-date figures.

Selling, General and Administrative Expenses (SG&A): Overhead or expenses involved in running a business.

Write-off: An asset that is depreciated to zero.