Top 5 Mistakes Business Owners Make When Doing Their Own Bookkeeping

Many business owners prefer to do their own bookkeeping or delegate it to a spouse or secretary. This helps to save them money on accounting fees, but it usually results in inaccurate and messy financials that don’t adhere to GAAP or U.S. accounting standards.

When a company is small and its transactions are minimal, sometimes keeping your bookkeeping in house makes sense. After all, it doesn’t take one long to enter a few checks and deposits each month. And many tax accountants will review and clean up the books quickly for you before filing income taxes. But as a company grows, there comes a point when doing it yourself takes away too much valuable time from your busy schedule, and waiting till year end to have anyone look at the bookkeeping becomes too big a chore for someone to take on all at once.

Another time when companies see the folly in doing their own bookkeeping is when they need a bank loan, but their financial statements are so inaccurate and disorganized that the bank will not approve them. A bank will trust an outside accounting firm’s work before it will trust an inexperienced owner’s.

Once a company starts experiencing cash flow issues resulting from poorly managed accounts receivable, large cash purchases, inaccurate and unreconciled bank balances, poor inventory management, embezzlement, and so on, they start to realize that taking their accounting seriously and handing it over to a professional is the best option.

If a business ever wants to bring on investors or partners, having clean, accurate, GAAP compliant financials is crucial. Savvy investors will not trust statements produced by unqualified people.

There are many bookkeeping mistakes made by owners that I’ve encountered over the years. While we don’t have time to explore every kind of error, I’ve chosen five of the most common mistakes that I tend to see.

Loan Payments

A mistake that I know I’ll almost always see when reviewing the accounting work of an owner is the failure to recognize the different components of a loan payment. Each payment is comprised of a payback of the principal borrowed as well as interest, which is how the lender makes money off the loan. You can find the monthly principal and interest breakdown by looking at the amortization schedule for the loan.

In case you don’t have a schedule from the bank, if you know the term, interest rate and original loan amount, you can create an amortization via an excel spreadsheet that should come out close to the actual amortization schedule. In accounting, the principal amount is debited to a notes payable account, while the interest portion is debited to an expense account.

The problem is most of the time owners take the full loan payment to either an expense account, to the notes payable account, and I’ve even seen it taken to a fixed asset account. They also often fail to make an adjusting entry at year end to allocate the amounts between principal and interest. So, loan payments are one of the first things I look at when cleaning up an owner’s work.

Fixed Assets

Fixed assets include large equipment, expensive tools, furniture and fixtures, buildings, land, patents, copyrights, goodwill, and any other item that has a usable life over one year. Owners get confused when they hear that assets are any items that last over a year and are not told what a capitalization threshold is. So, they end up taking inexpensive items to fixed assets. Or sometimes they just expense everything regardless of the price.

Every business should set a capitalization threshold, or the amount at which a purchase of one of the items listed above is recorded as a fixed asset vs the amount at which such an item is expensed.

A small company can set whatever capitalization limit it wants, but most of the time the limit ranges between $500 and $2,500 because a business is allowed to deduct any item costing 2,500 or less on their tax return provided they fill out a de minimis safe harbor election on the return, have a written capitalization policy of 2,500, and apply that threshold to all asset purchases throughout the tax year.

Another way in which owners tend to mess up fixed assets is by not depreciating or amortizing them or by depreciating incorrectly. Depreciation and amortization are how you recognize the expense of fixed assets over the life of the items. Depreciation is a concept that applies to physical items like equipment, while amortization applies to intangible assets such as copyrights. 

There are certain approved methods for depreciation and amortization. The easiest one to follow is the straight line method. Under that approach, you simply take the cost of the asset minus any salvage value you estimate the item to have at the end of its useful life and then divide that figure by the estimated number of years the asset will be used by your company. That is how much you need to depreciate or amortize each year.

Personal Expenses

When a business account is used to pay for the personal expense of an owner, it should never go down as a business expense. It should be recorded in an equity account such as Owner’s Draws, Partner’s Draws, or Shareholder’s Distributions depending on the type of business one has.

I’ve seen a lot of different personal costs show up on bank accounts, including gambling expenses, vacation expenses, liquor store purchases, grocery costs, gas for personal vehicles, restaurant meals outside of work hours, and more.

Sometimes owners purposefully try to represent personal expenses as business expenses to lower their income tax liability, while other times they simply don’t communicate with their bookkeeper about what is personal.

Whatever the case, mixing business and personal expenses in your business account is never a good idea. If you’re ever audited, auditors will see that as a huge red flag and will want to comb through all of your expenses and make you prove the business purpose behind them.

Redundant Accounts

You know you have an amateur bookkeeper when the income statement is multiple pages long. Due to not being familiar with what the standard chart of accounts should look like for their type of company and what should be included in each account, most small business owners create too many accounts on their P&L and Balance Sheet. 

Many times you find redundancy or the tendency to place similar transactions in different accounts when they could have gone together. You also see atypical names for accounts instead of ones that are commonly used in accounting.

Lenders and investors want to see clean, standardized financials with well categorized transactions. A long and messy list of accounts makes them wonder about the ability of the bookkeeper and that consequently makes them question the validity of the totals. 

Account Reconciliations

When I see a negative balance in an account, I know that it has either never been reconciled or was reconciled improperly.

Ideally, every balance sheet account should be reconciled on a monthly basis. At the very least, your bank and credit card accounts should be kept reconciled. Reconciliation is how you spot and correct errors and omissions. Because most if not all of the transactions in your business come through the bank or credit card accounts, they are the most pivotal ones to keep balanced. Without regular reconciliations, your account balances cannot be relied on.

Many business owners either neglect to reconcile accounts regularly or simply don’t know how to do it properly. Accounts like accounts receivable and accounts payable, especially, can be tricky to reconcile if you haven’t been trained. 

Keep in mind also that the quality of your bookkeeping directly affects your ability to reconcile accounts. If you are not following proper bookkeeping practices then it follows that your accounts will not be right and you will find it impossible to reconcile them. For instance, if you are not separating the interest portion from the principal part of each loan payment, the loan balance on your books will never match what the lender says you owe.

If you’re having trouble keeping up with your bookkeeping or not sure if it’s correct, consider contacting AccountAlytix. We can manage your books for you or serve as an outside controller/CFO to review, adjust, and advise.