Three Common Accounting Mistakes
Tax time isn't the only time business owners should review their accounting practices. Experts say small-business owners often make seemingly simple accounting mistakes that -- which at their most extreme -- could mean the difference between a good and bad fiscal year. Here are three common missteps entrepreneurs make and the lessons you can learn from them.
Mistake No.1: You treat sales as revenue before the product or service is delivered.
Stuart Reisch, co-founder of Transform, a company that makes custom storage units, learned this the hard way after unwittingly counting deposits as income his first year in business in 1999. The New Rochelle, N.Y.-based company had $1.2 million in expenses versus about $1.4 million in sales, resulting in what looked like a $200,000 profit. However, $200,000 worth of products that were sold weren't actually installed until January of the next year. As a result, Reisch ultimately had to revise the company's financials and realized the business had only broken even -- not earned a profit after all. He then decided to temporarily halt plans for growth.
"[Instead] we worked on cost containment to improve our bottom line," says Reisch, whose 65-employee company now has annual revenues of $6.5 million. "By the mid-point of the following year, we [were able to] modestly increase advertising and add a salesperson."
Lesson learned: When you make a sale, don't count it as income until your company has delivered the product or service to the customer, according to Christopher G. Gamble, a certified public accountant at Kroner Gamble & Co., a Rochester, N.Y.-based accounting and financial-planning firm. Great sales in a month that will be delivered to the customer later, but are improperly posted as revenue for the current period, can give a company a false sense of profitability, Reisch cautions.
Mistake No. 2: You don't consider the financial ramifications of a large purchase, such as equipment.
When you pay cash for a new server or piece of equipment, one of the benefits is that you can depreciate the equipment over time. But experts say dipping too far into cash reserves can put a business at risk in more ways than one.
"What many business owners don't understand is that making a capital expenditure on equipment or furnishings not only depletes their cash reserve in the short term, but will come back to bite them at tax time," says Franka Winchester, founding partner of Pacific Crest Group, a Larkspur, Calif.-based business- management and financial-services firm. For example, when you have to gradually write off a large asset you can't claim it as a one-time expense on your taxes, according to Winchester. And if you can't claim that expense to offset profits, your business will likely be on the hook to pay more come tax time.
Lesson learned: When making a major purchase, such as equipment, consider a short-term loan if purchasing with cash would put a serious dent in your reserves. Using a credit card is an option for items you know you can pay off in a few months, but beware of high interest rates. Leasing is also an alternative if, say, the equipment you're considering requires periodic updates or you need to use an item only temporarily.
Mistake No. 3: You confuse profits for cash flow.
When Anne-Marie Faiola tried to ramp up expansion of her soap-making supply company shortly after its founding in 1998, she couldn't figure out why she was showing a profit on paper but never seemed to have any cash left at the end of the month. As it turns out, she was spending money on product development faster than she could earn it back. Her business was staying afloat by borrowing from credit cards and a line of credit. "If you do that for too many years, you will find yourself heavily in debt -- while still being profitable -- and wondering why you can't seem to get ahead," says Faiola, founder of Bellingham, Wash.-based BrambleBerry.com, which now generates annual revenue of $1.2 million. Once Faiola realized more money was going out than coming in, she slowed spending on new products for three years to curb debt.
Lesson learned: Always track what you're spending versus selling -- and take a long, hard look at your financials before moving ahead with expansion plans that would put your business too far into debt.