How does one know that a business is doing well?
By their cool videos or beautiful content? The amount of sales the business has annually? By their sharp looking employees?
Negative, the performance and health of a business can be determined from accurate bookkeeping. Bookkeeping all starts with bank statements, and bank statements don’t lie (or very rarely).
When completing monthly bookkeeping there are three main components:
- Recording accounting transactions – This includes recording income, business expenses, assets, liabilities, equity, and some rare other types of accounting transactions
- Performing bank reconciliations – Making sure the number of deposits and withdrawal transactions in the bank statements matches the number deposits and withdrawals in the accounting system for the month. It prevents and detects errors in the books and the bank. It is rare that bank statements have errors, but it does happen
- Creating monthly financial statements – primarily the profit & loss (income statement) and balance sheet. Just because accounting transactions and bank reconciliations are complete does need mean the financial statements are correct. The balance sheet needs to follow the correct format based on the tax entity of the company (partnership, S Corp, C Corp, etc.) For instance, if the business is a partnership, the terms equity or distributions should not be used. A partnership balance sheet should show capital balances for each partner, and instead of distributions, a partnership has withdrawals for each partner.
Common bookkeeping problems
QuickBooks Online does everything for me
QuickBooks Online reads the bank transactions and attempts to guess what expense account to use for each bank transaction, but often the guess is wrong. Thinking QBO does everything for the business owner leads to very inaccurate financial statements. Also, there are expense accounts such as depreciation expense that require a journal entry to be created. The same goes for payroll, recording what came through the bank is not accurate for payroll expenses.Payroll requires a journal entry to be made to gross up payroll to the correct amount and adjusting payroll taxes accordingly to match 941’s and 940’s filed by your payroll processor with the IRS.
QuickBooks Online by default even suggests expense account names that are errors if used. Two of these QuickBooks Online bad expense account names are “Owner’s Pay & Personal Expenses” and “Meals & Entertainment”. “Owners Pay & Personal Expenses” is not an expense on the profit & loss and should be replaced with the term “Shareholder distributions” if the Company is an S Corp. Distributions are not owner’s pay, they are a reduction of equity on the balance sheet. This is a common mistake made my novice bookkeepers.
Starting in 2018, Entertainment is no longer deductible under the Tax Cuts and Jobs Act, so why in the world would QuickBooks Online group meals and entertainment together when meals can be deductible but entertainment cannot. The correct thing to do is just show “meals expense” and entertainment should be recorded under shareholder distributions or partner withdrawals (again based on the tax entity).
Lack of accounting knowledge or financial reporting experience
Sorry to be harsh, but often this comes from having a QuickBooks Online certification, but the bookkeeper does not have a four-year accounting degree. I am speaking from a lot of experience here. Many bookkeepers can get the profit & loss close to accurate, but the balance sheet is much more difficult. This is where many bookkeepers lack the education and experience to produce an accurate balance sheet.
Why is a balance sheet important? Well for one, if a business has over $250k sales of $250k assets in a particular year, their S Corp tax return, partnership tax return (Form 1065), requires an accurate balance sheet.
A balance sheet that does not make sense that is placed on a business tax return can lead to IRS audit and penalties.
Messy books
QuickBooks Online might seem like an easy program but its not. One click of a wrong button causes duplicate sales. Balances such as undeposited funds end up getting shown which means something went wrong. Too much business mixed in with personal transactions. Too many expense account names that don’t make sense or an overuse of expense accounts with the word “Other” included (ie. Other expenses), another quick way to cause an IRS audit. Balances going the incorrect direction such as negative accounts receivable balances or liabilities that are shown negative so they end up looking like assets.
Simpson & Simpson Accounting has worked with many clients to cleanup messy books. Please feel free to reach out for a free 30-minute consultation.