Maintaining accurate and detailed financial records is crucial for small business owners. Proper business expense tracking not only ensures compliance with tax laws but also helps in making informed financial decisions. This article will guide you through the best practices for keeping track of taxes for a small business.
What Are Business Expenses?
Business expenses fall into two main categories:
- Cost of Goods Sold (COGS): These are expenses directly related to the production of your products.
- General Operating Expenses: These include all other necessary, day-to-day costs involved in running your business, such as rent, taxes, employee salaries, and permits.
To better track and manage your small business expenses, you can further break them down. For instance, you can separate fixed and variable costs and list depreciation and interest separately.
Benefits of Tracking Business Expenses
1. Organized Books
Keeping accurate financial records ensures you are well-prepared for various scenarios, such as tax season, an IRS audit, or applying for business financing. Well-organized books provide a clear financial picture and help in maintaining compliance.
2. Spending Clarity
Monitoring where your money goes gives you a clear understanding of your business expenditures. This insight allows you to identify areas where you can cut costs, ultimately improving your cash flow and financial health.
3. Tax Savings
Many business expenses are tax-deductible, which can lower your taxable income. Diligent expense tracking provides the necessary documentation to support tax deduction claims, ensuring you maximize your savings during tax season.
4. Improved Financial Planning
Regularly reviewing your expenses and generating reports can help identify spending trends and areas of overspending. This information enables you to make informed adjustments and plan for future financial needs effectively.
5. Fraud Detection
Keeping a close watch on your expenses makes it easier to detect and address any instances of financial fraud. Regular monitoring helps ensure the integrity of your financial transactions and safeguards your business against fraudulent activities.
Setting Up an Effective Expense Tracking System
1. Separate Bank Account
The first step in tracking business expenses is to open a separate bank account for your business. This includes a business checking account and a business savings account. Keeping personal and business expenses separate simplifies your financial transactions and ensures clarity during tax season.
2. Choose Accounting Software
Investing in good accounting software is essential for efficient business expense tracking. Accounting software like QuickBooks, FreshBooks, and Xero can automate many processes, provide financial reporting tools, and help you maintain accurate records.
3. Connect Your Financial Institutions
To streamline the tracking of business expenses, connect your accounting software to your bank accounts. This allows for the automatic downloading and categorizing of all bank transactions. Additionally, you can import daily transactions and download bank statements, simplifying the process of reconciling statements.
By integrating your bank accounts with your accounting software, you can manage banking transactions directly within the software, eliminating the need to log into your bank account separately. This synchronization saves time on expense tracking and ensures you maintain an accurate record of income and expenses, minimizing the risk of missing any transactions.
4. Record Income and Expenses
Regularly record income and expenses to keep your books updated. This can be done on a monthly basis to ensure that all financial transactions are accounted for. Digitize receipts and scan receipts to keep a digital copy, reducing the reliance on paper receipts.
Managing Paper Receipts
If possible, opt for using your business credit card over cash to minimize paper receipts, as cash transactions are harder to track. Maintaining and organizing paper receipts is crucial, as they serve as evidence for tax deductions and contribute to the accuracy of your financial records.
Here are some strategies to effectively organize paper receipts for your small business expenses:
- Dedicated Compartment: Reserve a separate section in your purse, wallet, or bag specifically for business receipts. If daily filing seems daunting, allocate time weekly, such as Friday afternoons, to sort and file receipts, ensuring consistency by scheduling it as a recurring task on your calendar.
- Utilize File Folders: Create monthly file folders at the start of the year and categorize receipts accordingly. Store them in either a filing cabinet or an accordion folder, simplifying expense tracking with a dedicated folder for each category.
- Binder Organization: Employ binders with labeled plastic sleeves, sorted by month or category for efficient tracking, particularly beneficial when managing numerous receipts.
- Digital Transformation: Explore receipt scanner apps that enable scanning and storage of receipts using your mobile device, seamlessly integrating with accounting software. This digitization streamlines receipt management and safeguards them electronically, eliminating the need for paper backups.
- Detailed Notations: Always annotate receipts with the purpose of each purchase to enhance clarity and relevance. Recording details like the context of a purchase transforms a random receipt into valuable proof of business expense.
Additionally, maintaining a detailed business calendar, whether digital or physical, serves as a backup reference, aiding in retrospective analysis and record verification.
Remember, the IRS mandates small business owners to retain receipts and supporting documentation, including bank statements, for a minimum of three years.
Digital Receipts
Explore receipt scanner apps for digital storage of business expense receipts, eliminating the need for paper backups. Applications like FreshBooks offer features to photograph and store receipts in the cloud, seamlessly integrating with accounting systems, thus simplifying expense tracking and management.
Furthermore, don’t overlook tracking mileage if you utilize a vehicle for business purposes, as mileage can be claimed as a tax deduction.
Utilizing a business expense tracker app provides insights into expenditure patterns, aiding in budgeting and financial management.
5. Evaluate Your Business Expenditures
To ensure effective business expense tracking, periodically assess your expenses. Review reports diligently, scrutinize figures, and conduct thorough analyses. Identify spending patterns to understand expenditures in specific areas and their cumulative impact. Additionally, rectify any errors or oversights.
Conducting regular reviews of your business finances unveils its financial health and empowers you to make informed decisions crucial for business development. By staying vigilant and proactive in expense management, you pave the way for your business’s growth and success.
Preparing for Tax Time
Organize Records
As tax season approaches, organizing your records becomes crucial. Ensure all business expenses are documented and categorized. Scan receipts and digitize all physical copies. This will help in providing proof of expenses in case of an audit.
Calculate Tax Deductions
Understand and calculate your tax deductions. Common tax deductions for small businesses include office expenses, travel, advertising, and salaries paid to employees. Proper expense tracking ensures you don’t miss out on any eligible tax deductions.
Review Financial Statements
Regularly review your financial statements to ensure accuracy. Check your profit and loss statement, balance sheet, and cash flow statement. This review helps in understanding your organization’s taxable business income and preparing accurate tax returns.
Common Mistakes to Avoid
Mixing Personal and Business Expenses
Always use a separate bank account for your business. Mixing personal and business expenses can complicate your finances and cause issues during tax filing.
Not Keeping Receipts
Failure to keep receipts can lead to problems if you’re audited. Digitize receipts and keep a backup of all transactions.
Ignoring Small Expenses
Small expenses add up. Track all business expenses, no matter how minor they seem. This ensures a complete financial picture and maximizes your tax deductions.
Vyde: Your Own Accounting Department All Rolled Into One
Hiring an Accountant: As your business grows, consider hiring an accountant. A professional can help you set up an efficient accounting system, ensure compliance with tax laws, and provide valuable financial advice, helping your business stay on track and make informed decisions.
Using Bookkeeping Services: If managing finances isn’t your strong suit, bookkeeping services can be invaluable. They handle day-to-day business tracking, ensuring all transactions are recorded accurately and expenses are properly categorized, freeing up your time to focus on growing your business.
With Vyde, you have your own accounting department all rolled into one, providing comprehensive solutions to manage your financial needs seamlessly.
FAQs for “How to Keep Track of Taxes for a Small Business
1. Why is tracking business expenses important for small businesses?
Tracking business expenses is vital for small businesses for several reasons. It ensures compliance with tax regulations, provides insights into the financial health of the business, aids in making informed financial decisions, and maximizes tax deductions.
2. What are some best practices for setting up an effective expense tracking system?
Setting up an effective expense tracking system involves opening a separate bank account for the business, investing in reliable accounting software, connecting financial institutions for automatic transaction downloads, and regularly recording income and expenses.
3. How can small businesses effectively manage paper receipts?
Small businesses can effectively manage paper receipts by implementing strategies such as dedicating a separate compartment for business receipts, using file folders or binders for organization, digitizing receipts using scanner apps, and maintaining detailed notations on each receipt.
4. What technology can small businesses leverage for expense tracking?
Small businesses can leverage technology for expense tracking by using accounting software with features like receipt scanning and digitization, mobile apps for on-the-go tracking, and bank account integration for automatic transaction imports.
5. What steps should small businesses take to prepare for tax time?
To prepare for tax time, small businesses should organize their records, calculate tax deductions accurately, review financial statements for accuracy, avoid common mistakes like mixing personal and business expenses, and consider seeking professional help from accountants or bookkeeping services.
