Bookkeeping is indispensable to the success of your organization. If you have no idea where your money is being spent, how can you cut costs or pinpoint the right growth strategies? Yet, a recent study found that only 60% of business owners feel confident when it comes to bookkeeping.

If you are a part of that statistic, don’t worry. In this guide, we’ll explain why bookkeeping is important, cover common mistakes and how to avoid them, and highlight bookkeeping best practices.

Before we get into the details of bookkeeping, it’s important to differentiate bookkeeping from accounting. Although these roles overlap, there are some key differences. Bookkeeping is focused on transaction management, while accounting analyzes the big picture, such as tax compliance. The reports bookkeepers produce will be used by accountants, making it important to set a strong tone at the top. Let’s dive in.

Why is Bookkeeping Important?
Organized financial records set the foundation for accuracy, compliance, and insights into performance. Here are a few more reasons why bookkeeping should be a priority in your company.

Banks Ask for It
Most businesses leverage debt financing for general operations, expansion initiatives, and equipment purchases. One of the first pieces of information lenders will request is your financial statements. This includes a balance sheet, an income statement, and a statement of cash flows. If you are months behind on your bookkeeping, you risk sending inaccurate financial statements. Not only can this land you in legal trouble, but it might also lead to a lower loan amount.
For example, let’s say that you haven’t completed any bookkeeping for six months and have been solely relying on downloaded transactions in your accounting software. Income could be misreported, transactions could be doubled up, and inventory counts could be off.
Overall, the statements you send your lender won’t be a true depiction of your financial health. Not to mention that trying to catch up on your accounting records can take weeks, delaying financing that you might be relying on to keep the doors open. 

Buyers Ask for It
With countless Americans breaking out of the 9-5 role, looking to be their own boss, now might be the right time to sell your business. You don’t want the roadblock of outdated bookkeeping getting in your way. On average, it can take anywhere from six to ten months to sell a business with fluid communication and document requests. Cleaning up your bookkeeping records can take months, further delaying the sale.
Moreover, financial statements generated by your internal bookkeeping team will be one of the primary drivers of a successful business sale. Buyers are looking for companies with growing sales, strong accounts receivable controls, and steady cash flow. Even if you know your business meets this criteria, you still need to prove it to buyers through your financial statements like current accounts receivable aging schedules, income statements, balance sheets, and bank statements.

Tax Planning Relies on It
As your business begins to grow, you might notice your tax liability increasing. Small business owners can pay almost 40% in taxes, depending on your business structure. How would you like to turn over $40 for every $100 you make to Uncle Sam? The good news is that there are strategies you can implement to lower your tax burden each year.
However, these strategies rely on having an accurate picture of your financial system. For example, if you have excess income, maybe you purchase that new piece of machinery you’ve been needing or you decide to defer excess income until the new year. The most effective time to tax plan is before year-end, which is why bookkeeping is so important throughout the year. You don’t want to miss the opportunity to save on taxes because you neglected bookkeeping for the past nine months.

Major Contracts Request It
Government contractors are held to higher standards, requiring full compliance with Federal regulations on invoicing and bill collection. Failure to follow these standards can preclude you from securing contracts in the future, hindering the success of your organization. Even if you don’t contract with government agencies, many customers will require proof of financial stability before signing a large contract.
Why is this the case? The government and customers with large contracts want to be sure you have the resources to effectively complete the job. If you boast millions of dollars in machinery, but your balance sheet only says $500,000, this is a serious issue. It’s best to be prepared to furnish financial information before you submit a bid for a large contract.

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Cash Flow Depends on It
Cash flow is one of the top downfalls of small businesses. Without regular bookkeeping, you have no idea of what funds are flowing in and out of your company. This can lead to delayed collections of receivables and missing vendor payments, both of which harm the financial health of your business.
Moreover, neglecting bookkeeping can be detrimental to the longevity of your business. Maybe your checking account is showing $100,000 of cash on hand, so you decide to purchase a new piece of equipment for $20,000. What happens if you forget to enter $40,000 worth of outstanding checks and your true balance is only $60,000? Would you still have purchased that piece of equipment?

Common Bookkeeping Mistakes and How to Avoid Them
Now that we’ve covered the importance of bookkeeping, let’s go through some common bookkeeping mistakes and how you can avoid them.

Neglecting the Books Until Year-End
By now, you should understand the importance of staying on top of your bookkeeping. Unfortunately, when times get busy, bookkeeping tends to be the first thing lowered on the totem pole. Leaving your books untouched until year-end can have some serious consequences. For one, you open the door to more errors. It’s much easier to remember a transaction that happened last month compared to six months ago.
Additionally, you risk missing transactions, resulting in a higher tax liability. To avoid this common mistake, dedicate time each month to reconciling your accounts. Pencil it in the calendar or set a reminder. Just a few hours each month can make a significant difference in the accuracy of your books.

Improperly Categorizing Income and Expenses
The categorization of your income and expenses does matter. For example, meals are only 50% deductible, while entertainment is a non-deductible expense. If you misclassify items to these accounts, you are increasing your taxable income. In addition, interest income is not taxed the same as regular sales income. You need to be sure you are properly categorizing transactions to generate accurate tax returns and financial statements.
When it comes to your bank downloaded transactions, take the time to review the validity. It’s common for software to misclassify transactions. In addition, pay close attention when you are completing bank reconciliations. Don’t be afraid to spend extra time ensuring the accuracy of your categorizations.

Misclassifying Employees and Contractors
Employees and independent contractors are treated differently in the eyes of the IRS. Misclassifying an employee as a contractor could subject you to back taxes with harsh fines and penalties. Before you pay a new worker, go through The Common Law Rules outlined by the IRS. This is a three-part test that helps you determine which type of worker you have.
Next, be sure your accounting software reflects the proper information. In most cases, you need to check a box indicating the worker is an independent contractor. This will populate the amount paid to the contractor on the 1099 report at year-end.

Avoiding Sales Tax
Sales tax is more complex following the South Dakota vs Wayfair case. Even if you aren’t an e-commerce seller, selling across state lines might require you to file and pay sales tax in multiple states. When setting up an invoice for a customer, be sure you have the right shipping address. This ensures that sales are reported in the correct state. To avoid missing sales tax, check on your sales to each state on a monthly basis. Most accounting software programs have a report you can utilize.

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Forgetting to View Financial Reports
Financial reports serve as your double check. Too often, business owners make the mistake of neglecting the review of these reports until year-end. Once your bank reconciliations are completed each month, you should review the basic financial reports, including the accounts receivable aging schedule, the accounts payable aging schedule, the income statement, and the balance sheet. Adding these to your standard monthly processes improves your oversight and transparency into the financial health of your company.

Foregoing Accounting Software
As you’ve noticed, we’ve talked a lot about accounting software. Accounting software eliminates the need for mundane data entry, allowing you to infuse efficiency into your bookkeeping. Not only is this a cost-effective approach, but it also reduces your risk of human error. If you aren’t already using accounting software, take the time to find the right program and make the transition.

Bookkeeping Best Practices
Taking on the bookkeeping in your company can feel overwhelming, which is why we’ve compiled a list of bookkeeping best practices for you to follow. Keep in mind that the processes that work best for your company depend on your industry, types of transactions, and strategic goals. Nevertheless, here’s a starting point.

Review Transactions
Throughout the month, review your transactions. The level of transactions your business has will dictate how often you should be categorizing income and expenses. For example, if your business only has 50 transactions a month, you might only need to categorize transactions once a week or monthly. However, if your business has thousands of transactions each month, daily categorization might be needed.

Reconcile Accounts Monthly
Each month, when your bank and credit card providers send you statements, go into your accounting software and complete the reconciliation process. Reconciling your accounts matches what actually cleared the bank with the transactions currently in your cash ledger. Follow up on any discrepancies. It’s not uncommon for banks to make mistakes, such as transposing check numbers or assessing unknown fees.

Track AP and AR Aging Schedules
Another bookkeeping best practice is to track your accounts receivable and accounts payable aging schedules. These documents monitor how much customers owe you and how much your business owes to third parties, like suppliers. Tracking these reports is important for managing cash flow. For example, you might find that a customer has a three-month-old balance. Knowing this information allows you to follow up on when you can expect the payment.

Tax Plan on a Regular Basis
Tax planning is important to minimize your liability. On a regular basis, such as quarterly, make it a priority to project your income through the end of the year. This is especially important if you are required to make quarterly estimated payments. If you are unsure of which tax planning strategies work best for your business, reach out to a qualified accountant.

Optimize Your Chart of Accounts
Your chart of accounts dictates how your transactions will be categorized. Optimizing your chart of accounts can lead to more clarity in your financial reporting and help you effectively plan for growth. For instance, let’s say you have an office and a warehouse location. If you only have one rent account, it can be difficult to separate cost of goods sold from general and administrative expenses. By creating an office rent and a warehouse rent account, you are generating more clarity in the breakdown of rent.

Establish Internal Guidelines
Internal controls are essential when trying to minimize the risk of fraud and streamline your bookkeeping processes. Take the time to develop an outline for how bookkeeping should be completed each month, including the roles of each team member. Maybe you decide that one person will handle accounts payable and another individual will reconcile your bank accounts. However, if you are in the growth phase and don’t have enough employees to separate roles, consider outsourcing your accounting.

Getting Started
Are you ready to tackle the bookkeeping in your business? Getting started can be difficult, which is why our team at BUSINESS is here to help. Reach out today to schedule your free consultation.

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