Accounting is essential for any business, regardless of size or industry. It provides companies with the financial information they need to make informed decisions, track their financial and overall progress, and comply with set tax regulations. In 2023, with the evolving global and economic landscape, there are many accounting questions for small business owners to pay heed to ensure their financial well-being.
To help you find the most important small business accounting questions, we consulted with CPA Wendy Barlin, who answered the 14 most essential accounting questions businesses need to ask in 2023. By understanding these accounting problems, companies can ensure they take steps to protect their financial health and future success.
#1: Should Business Owners Have Separate Bank Accounts for Business and Personal Transactions?
It's always best practice to have separate accounts for business and personal transactions, as it helps with tax simplification. The IRS, too, recommends that SMB owners have different bank accounts.
Benefits of Separating Personal and Business Finances
- From a risk management perspective: If your personal and business finances are mixed, and something happens to your business, such as a lawsuit or bankruptcy, your personal assets could be at risk. A separate business account can help protect your assets from business liabilities.
- From an accounting perspective: Tracking your business finances separately makes it much easier to prepare your taxes, track your cash flow, and make informed business decisions.
- From a finance perspective: Having separate business credit cards and accounts makes it easier to see how much money is coming in and going out of your business making cash flow management a breeze.
- From a tax perspective: Some business expenses are tax deductible, but only if paid with a business account. A separate business account lets you easily track deductible expenses and save money on taxes.
- From a professional perspective: Having a separate business account makes your business look more professional and established. This also increases the credibility of your business. When you have a separate account, it shows that you are serious about your business and that you are taking steps to manage your finances properly.
#2: All You Need to Know About Accounting: Common Accounting Terms
1. What Is the Difference Between Bookkeeping and Record Keeping?
Bookkeeping is the process of tracking and maintaining records for all financial transactions of a business. It involves recording all transactions, such as sales, purchases, and expenses. Bookkeeping is essential for businesses of all sizes, as it helps make better financial decisions.
Record keeping is the broader term that encompasses all aspects of maintaining financial records. It includes bookkeeping and other activities such as archiving documents, creating reports, and managing accounting software.
Main Differences Between Bookkeeping and Record keeping
The main difference between bookkeeping and record keeping is while bookkeeping focuses on recording all financial transactions, record keeping is a broader term encompassing all aspects of maintaining financial records.
2. What Is the Difference Between Cash and Accrual Basis Accounting?
The cash basis of accounting records revenues when cash is received and expenses when cash is paid out. This method is simple to understand and use. But it can be inaccurate as it does not account for revenue or expenses that have been incurred but not yet received or paid.
The accrual basis of accounting records revenues when they are earned and expenses when resources are used. This method is more accurate than the cash basis because it accounts for all transactions, regardless of when cash is received or paid.
Main Differences Between Cash and Accrual Accounting
Which accounting method is right for your US SMB?
The ideal accounting procedure for a US SMB will vary depending on its unique requirements. Cash basis accounting is an option for small enterprises that do not require a detailed view of their financial performance. Larger companies, on the other hand, will need to employ accrual basis accounting in order to get a more accurate view of their financial performance.
3. What Is a Balance Sheet?
A balance sheet is a financial statement that shows, at a point in time, how much you have versus how much you owe. In other words, the term balance sheet refers to a financial statement that reports a company's assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company's capital structure.
Further, a positive balance sheet means you have more money than you owe. A negative balance sheet means you owe more money than you have, which is a cause for concern and a sign to take massive action. In this way, balance sheets are extremely useful to you as a business owner.
4. What Is the Difference Between an Income Statement or a Profit & Loss Statement?
An income statement is a financial statement that reports an organization’s financial performance over a particular accounting period.
The profit and loss statement (P&L statement) is a financial statement that summarises your business’s cost, revenue, and expenses during a specific period.
Main Differences Between Income Statement or Profit & Loss Statement
Which financial statement is right for your US SMB?
Both income statements and P&L statements are important financial statements for businesses. However, the P&L statement is more commonly used by businesses because it provides a more complete picture of the financial performance of the business.
Whichever statement you decide to use, I recommend regularly reviewing your income statements/P&L statements.
5. What are Credit Card Reconciliations?
Credit card reconciliation is the accounting process of comparing financial transactions and activities to their supporting documentation. It ensures that values on two sets of records are correct and in agreement.
Accountants will often ask you if you have done a reconciliation. This is just a fancy way of saying “matching.”
For instance, you would match the transactions in your business credit card statements to a third party, like a bank. This process is called credit card reconciliation, and it ensures data integrity.
Data integrity is essential for business management and tax compliance. Accurate data is essential for making informed decisions about your business, such as tracking sales, expenses, and inventory levels. This basic accounting information can help you identify trends, set goals, and make sure your business is on track.
The IRS also requires businesses to keep accurate records of their financial transactions. If the IRS audits you, you will need to provide proof of your data integrity. This means that you need to have a system in place to track and maintain your data in a secure and reliable way.
#3 Would Finance and Accounting Automation Help Get Rid of Manual and Error-Prone Workflows?
Yes! Even though formal bookkeeping is not required by law for unincorporated businesses or LLCs, Wendy recommends using accounting automation to streamline workflows and processes.
Human error is inevitable, and even the most detail-oriented people can make mistakes. These mistakes can be costly, both in terms of the misinformed business decisions and the serious income tax implications they can have.
#4 How Should SMBs Record and Report Their Business Transactions?
As an SMB owner, you can summarise your business transactions in books called journals or ledgers.
A journal is a book used to record each business transaction shown on your supporting documentation.
A ledger is a book that records all the totals from all your journals. It’s further organized into different accounts.
Off late, electronic software like accounting tools, point of sale software, expense management systems, and other financial software have been used to track business transactions. The rules that apply to hard copies, like journals and ledgers, also apply to electronic tools.
For more information on recording your business transactions, refer to IRS Publication 583, Starting a Business and Keeping Records.
Pro-tip: It's highly recommended you consider using an expense management software to record and report business transactions, as the software does all the heavy lifting while ensuring you stay tax compliant and ahead of the game with real-time visibility into business transactions across the board.
#5 What Are Some Mistakes SMBs Can Avoid While Filing Business Taxes?
SMB owners need to change their mindset about taxes. Most think of it as a chore they need to get out of the way as quickly as possible. But this mindset often leads to mistakes when filing and paying taxes.
Instead, SMB owners should view taxes as an opportunity to save money and protect their businesses. By taking the time to understand the tax code and plan, SMB owners can reduce their tax liability and avoid penalties.
4 common mistakes businesses can avoid when filing and paying business taxes
- Underpaying Estimated Taxes: A business owner must make an estimated tax payment if they expect to owe $1,000 or more in tax when they file their returns. If, by chance, they don’t pay enough tax through withholding and estimated tax payments, they may be charged a penalty. See the IRS Guide on Estimated Taxes and Who Must Pay Them to learn more about Estimated Taxes.
- Depositing Employment Taxes: Business owners with employees must deposit all employment taxes electronically through the Electronic Federal Tax Payment System (EFTPS). Ensure you deposit taxes correctly and on time to avoid a penalty.
- Filing Late: Businesses must file their tax returns on time, just like individuals. Failure to do so may cause penalties. Taxpayers should also know all tax requirements for their business with the filing deadlines.
- Not Separating Business and Personal Expenses: While using one credit card for personal and business expenses is tempting, it can be a major mistake for sole proprietors. This is mainly because tracking and categorizing expenses can be challenging, leading to errors when claiming tax deductions. Also, if your business gets pulled up by the IRS for an audit, the IRS may question any expenses not categorized as business-related.
#6: Would You Recommend Hiring a Professional for Small Business Bookkeeping?
Hiring a professional accountant or CPA can help your business save time and money, stay compliant with tax laws, and reduce risk. Being experts in accounting, tax, and financial planning, they can provide your business with valuable advice and services. They can also represent you if the IRS has questions or if you’re about to be audited.
If your budget allows, it's always best to hire a professional. They’ll keep your records for you so that you can focus on growing your business and using your financial reports to make strategic decisions.
#7: What Are the Best Ways to Store Your Financial Records?
As a small business owner, it is essential to store your financial records in a safe and secure manner. This is especially important for tax, as you may need to access your records to support your tax deductions and claims.
The best way to store your financial records is by securely making and saving digital copies of essential documents on the cloud. It also helps to put hard copies of the most crucial documents in a safe or deposit box.
Factors to consider when choosing a storage method for your financial records
- The amount of paperwork you have: If you have a lot of paperwork, you may need a robust storage solution, such as a fireproof safe or a cloud-based storage system.
- The frequency with which you access your records: If you need to access your records frequently, store them in a location that is easy to get to, such as a filing cabinet in your home office or workspace.
- The level of security you need: If you have sensitive financial information, you will need to choose a storage method that is secure, and that protects your information from unauthorized access.
#8: Why Good Record Keeping Is Important For Your Business?
- Helps monitor business progress: Records show if your business is improving, all the items you’re selling, and areas you’d need to change. Good records can ensure your company sustains in the long run.
- Preparing financial statements: Good records can help you easily prepare accurate financial statements like your income statements, profit and loss statements, and balance sheets.
- Identify sources of your revenue: As a business, you will receive money from multiple sources. Good records can help you identify all your sources of revenue. This basic accounting information can also help you separate personal receipts from business expenses.
- Keeping track of deductible expenses: If recorded, it is easy to keep track of your deductible expenses when you prepare to file your taxes.
- Preparing your business tax returns: To prepare for your tax returns, your records must support income, expenses, and the tax credits you report to the IRS.
- Support other items reported on your tax returns: The IRS can, at any point, request an official inspection of your business records. Hence it becomes crucial to ensure that they’re available. A good record keeping system will only speed up this process in case you ever get audited.
#9: How Often Should Businesses Do Bookkeeping?
I recommend doing your bookkeeping weekly.
This keeps the number of transactions down, helps me get quicker at using the software, and I can more easily remember items and transactions and have receipts handy.
What happens when you do your bookkeeping monthly?
I do have some clients who only work on the bookkeeping monthly, but then they need to dedicate an entire morning or more because of the volume and the time it takes to remind themselves of the steps to get the work done.
What happens when you do your bookkeeping quarterly?
Some clients even go as far as to do their bookkeeping quarterly, but here I see mistakes. The volume is overwhelming; you may become frustrated and look for shortcuts or make guesses. This is your hard-earned money. Treat it with respect and due care.
Hence, I recommend doing your bookkeeping weekly.
#10: How to identify and investigate unusual or suspicious transactions
Unusual transactions can be an early sign of fraud, money laundering, or other illegal activity. You can protect your business from financial losses and legal liabilities by investigating unusual transactions.
Examples of unusual transactions
- Large cash withdrawals or deposits
- Payments from unknown or suspicious persons
- Transactions that do not match your business's standard operating procedures
- Transactions that are made outside of your regular business hours
Take the time to look into transactions that seem unusual or don't make sense to you. I recommend doing this at the time and not setting issues aside to attend to later.
#11: How to Review Your Bookkeeping Reports
Bookkeeping is only as useful as the reports we create. They provide you with a snapshot of your business's financial health. By reviewing these reports regularly, you can identify any potential problems, such as fraudulent transactions or cash flow issues.
Each week I recommend you review your income and expenses against your budgeted expectations, your goals, and then your cash. These reports will show you how your business is doing and whether you need to implement any immediate changes or alter long-term plans.
Doing the work on bookkeeping is not enough. Your role as a business owner is to review the results of the bookkeeping system and then make strategic business choices to move your business toward your goal. If you struggle here, reach out to an accounting professional to help you read and understand your reports.
#12: How Can Businesses Lower Their Tax Liability?
Tax law says that any expenses are deductible for your business if they are “ordinary and necessary” for your business. This definition is extremely broad, so rather than guessing what is and isn’t deductible, I’d always recommend keeping track of every dollar and then working with a tax advisor to decide which expenses are, in fact, appropriate for you to deduct.
If you have not kept good records, your tax advisor cannot help you maximize your deductions. No records, no deduction.
Tax planning is also critical. Taxes are calculated on a cash basis, so whatever income you receive and expenses you incur during the tax year affect your taxable income. Working with a tax advisor to strategize and plan for taxes will save you thousands. Taxes are definitely not something that only needs your attention once a year.
To truly maximize your deductions and minimize your taxes, tax planning is the answer.
#13: What Are the Common Tax Mistakes Businesses Make and How Can They Be Avoided?
1. Not Hiring a Tax Advisor
Many small business owners try to save money by not hiring a tax advisor and turning to Google or friends or colleagues for tax advice. Taxes are very specific to your business and your situation.
Google and your friends and families may have some knowledge, but it is often generalized and inappropriate for you and your situation.
Get the advice of a professional to maximize your tax deductions and ensure you comply with the law.
2. Not asking enough small business accounting questions
Accounting is difficult but not impossible to learn for business owners. An easy way to get the hang of it would be to prepare questions for accountants or CPAs to help them get you up to speed.
As professionals, we are responsible for answering your questions and explaining how your taxes are calculated so that you are clear on every line of detail before you sign and submit your taxes.
I often receive calls from business owners who say they received an IRS notice and do not know what it is about because their tax preparer just told them to sign and did not explain any details. That is not ok. This is your business and your tax filing. Take responsibility for what you are signing, and keep asking questions until you understand.
#14: What Can Trigger an IRS Audit, and How Can an SMB Avoid It?
IRS audits are usually triggered by:
- Unusual income or expense items
- Misreporting of income and expenses
- Deductions that are disproportionate to your income
- Repeated claims of business losses year on year
- Misrepresentation of employees
Now, while there’s no guaranteed way to avoid an audit, there are certain precautions you can take to ensure your business doesn’t raise any red flags.
10 Ways Businesses Can Avoid a Tax Audit
- Don’t report a loss; rather, report a net profit.
- Be transparent about reported expenses. Categorize them.
- Provide all details for every expense reported.
- Always file your taxes on time. This will create a history of compliance.
- Avoid amending your returns. Double-check to see that each entry is correct.
- Avoid mathematical errors.
- Report exact errors. Do not round off values.
- Use a Schedule-C form to report earnings and losses.
- Do not leave empty fields on your tax returns. Fill out every answer.
- Always sign your tax return.
Each year, the IRS changes its audit focus based on areas of concern they noticed from prior years.
I always recommend that taxpayers focus on taking every deduction to which they are entitled, keeping good records, and not worrying about the risk of audit. If you have good records and have stayed within the law, then you have nothing to worry about.
Audits today are mostly by mail, so you will receive a letter in the mail asking for more basic accounting information. No one is coming to drag you out during the night or call you and demand immediate payment or pull cash from your bank account. None of these happen without you receiving many, many notices. So don't avoid IRS mailings. Most of the time, the issues are easily resolved with a letter.
Accounting is a vital tool for businesses of all sizes. By answering accounting problems and answers, businesses can better understand their finances and take steps to improve their financial health.
In addition to the 14 essential questions for accountants, businesses should regularly review their financial statements and accounting processes to ensure that they are accurate and up-to-date. They should also consult with a qualified accountant to get help with complex accounting issues.
By asking relevant small business accounting questions and taking steps to improve your financial health, businesses can set themselves up for success in 2023 and beyond.
This blog has been edited by Shruti Kesavan.