Top six bookkeeping mistakes you should avoid

Ninety per cent of small business failures are caused by poor cash flow, which largely stems from an inability to manage finances well. Sound financial management starts with an understanding of some basic rules of business bookkeeping, so here are six of the most common accounting and bookkeeping errors made by small businesses - and how you can avoid making them.

Using the wrong accounting method

There are two main business accounting methods: cash and accrual. Cash accounting is the simpler method because it's based on the actual flow of cash in and out of a business. The cash method is used primarily by sole proprietors and businesses with no inventory. On the flip side, accrual accounting records income and expenses as they occur, whether cash has actually changed hands or not.

As they grow and become more complex, most small businesses should switch to accrual accounting, because this makes it easier to accurately match revenue to expenses. Otherwise, the business might look profitable during months with few expenses and unprofitable during months with large expenses, with no way of really knowing the difference.

Combining personal and business finances

It's critical that personal and business finances be kept separate at all times, regardless of size. That's why one of the first things new business owners should do is open a business bank account and deposit all business income into this account.

Read more on separating personal from business obligations here >>

The next step is to work with an accountant to devise an earnings management strategy dictating how cash is removed from the business to meet investment, expenses and savings goals. Your earnings management strategy will be driven by such factors as how much of your profits need to be reinvested back into the company, the timing of payments for large business expenses, your cyclical or seasonal cash flow needs, and your long-term financial strategy.

Not performing basic account reconciliation

Reconciling your business's books with your business bank statement every month is one of your most fundamental accounting duties.

Account reconciliation is relatively simple: Just compare your books with your bank statement and make sure there are no discrepancies. If there are, contact your bank straight away to get them resolved. Doing this on a monthly basis helps ensure that accounting errors are caught and corrected quickly before they result in major financial problems.

Overlooking 'petty cash' reserves

Many businesses keep an informal stash of 'petty cash' that can be used by employees to cover small and incidental business expenses, such as postage stamps, snacks from vending machines, and office supplies. But just because the amounts are small doesn't mean that petty cash shouldn't be accounted for properly.

A simple accounting system for petty cash should log the amount of money that is initially put into the stash and requires workers to submit a petty cash slip each time they remove money. The slips should total the original amount of money put in when the petty cash stash is exhausted, and then a new stash can be started with a new petty cash deposit.

Not knowing the difference between profits and cash flow

A business can have positive cash flow in the short term but still be unprofitable; conversely, it can have negative short-term cash flow but still be profitable in the long term. The first scenario is common among small businesses because they often have to pay suppliers before they get paid by their customers. The second scenario is common among point-of-sale and cash-based businesses, such as retailers and restaurants that pay their vendors on terms.

Read more on how to differentiate between profit and cash flow, and on how to develop a forecasting plan here >>

Relying too heavily on a paperless environment

To reduce expenses and be better stewards of the environment, many companies today are trying to go paperless. In the realm of bookkeeping and accounting, however, there's simply no substitute for paper documentation and a paper trail, when needed.

There are many instances in which paper documentation of financial records will come in handy or be required. An ATO audit is one example - you don't want to be unable to produce requested financial documentation because it was lost in your computer system, or your system is temporarily down. While being environmentally conscious is important, bookkeeping isn't an area where you should skimp on the paper.

By Don Sadler of allbusiness.com

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