Stop Making These 5 Common Accounting Mistakes

Small business owners wear many hats. They are HR managers, marketing executives, and, of course, the Chief Financial Officer of their business. Most small business owners either manage their books independently or hire a bookkeeper to keep their finances in order. 

While this seems most practical, it can lead to avoidable mistakes that significantly impact a company’s bottom line. This may lead to inadequate cash flow, debt, and more taxable income than you’d like on your books. The best way to prevent these mistakes is to seek professional guidance who advises an internal stakeholder. That way, you are armed with the expertise and tools to give you accurate data and peace of mind. 

Mistake 1: Improperly Tracking Inventory

According to CNBC, businesses lose more than $1.75 trillion yearly due to overstocks, returns, and out-of-stock products. These discrepancies result from a gap between the items a business has on hand and the number of items recorded in its inventory system. Improperly tracking your inventory can hurt your business in other ways. This includes incorrect financial reporting, lost shareholder confidence, and cost control issues (including overstocking and understocking). Depending on the industry, these discrepancies can further disrupt production schedules and procurement processes. In the worst cases, these mistakes can turn into expensive tax penalties and legal issues. 

The best way to prevent these errors is to implement a system for lot tracking and cycle counting. Lot tracking assigns a batch number to products to monitor expiration dates, and control recalls. Cycle counting involves regularly checking a smaller inventory section to ensure physical counts match system records. This not only reduces waste and improves inventory valuation but also leads to more accurate financial reporting.

Mistake 2: Miscalculating Production Labor Costs

Material and labor costs are rising, so understanding the true cost of manufacturing or procurement costs is key to realizing profit. When costs fluctuate, your business needs real-time visibility into how changes impact the margin on each item so that you can adjust pricing or expenses. Understanding margins also allows your business to focus investment on higher-margin items. Often, the biggest hurdle to understanding production costs is labor costs. Inaccurate labor costs can lead to misallocated expenses and inaccurate COGS (cost of goods sold). 

Direct labor costs are directly tied to production and output (e.g., factory workers assembling products or the time it takes to pick and pack orders). Indirect labor costs are not directly involved in production (e.g., warehouse security). The distinction is important as the two types must be accounted for differently. The cost of direct labor is charged to all items produced within the reporting period, according to the hours of labor used in the production process. Indirect labor is charged to expenses in the reporting period. 

If these two labor types are not accounted for properly, inaccurate COGS metrics can result, which can have a domino effect on your financial statements. Inaccurate COGS impedes your understanding of the cost of producing or securing goods, leading to ineffective pricing, inaccurate production levels, and poor resource allocation. 

Involve a bookkeeping expert to ensure that labor types are categorized correctly. They can move beyond categorization and improve cost analysis, advise on pricing, and improve the accuracy of your financial statements overall.  LedgerFi is a bookkeeping and tax advisory solution founded by tax professionals who help empower and grow small businesses. With the right team behind your back, you can easily avoid these common accounting mistakes. 

Mistake 3: Underestimating or Underreporting on Taxes

Self-employed entrepreneurs, sole proprietors, partners, and S corporations must make quarterly tax payments based on their estimated tax bill for the year. Most businesses won’t know the exact amount, but making an accurate, data-driven decision will avoid fees and penalties due to underestimating or underpaying. If the IRS has reason to believe the business is “unreasonably careless” in reporting its income, or if the taxes owed are significantly understated, the business may be hit with penalties of up to 20%. If the IRS believes an attempt was made to defraud the government, fines can be as high as 75%. 

Mistake 4: Not Separating Profit Margins by Sales Channels

Many businesses mistakenly use a single profit margin figure, including all sales channels, which can be misleading. Different sales channels, like direct sales teams or online marketplaces, often have varying costs. To get a clear picture of profitability, tracking revenue and costs for each sales channel is crucial. This allows you to compare their performance, understand how much it costs to acquire customers through each channel, and allocate resources more effectively. Separating profit margins by sales channels allows you to maximize your overall profitability and make data-driven decisions about your sales strategy. Partner with an accounting partner that uses powerful reporting tools and professional expertise to guide your business decisions.

Mistake 5: Not Getting the Right Help

Many small business owners lack the financial expertise to handle complex accounting tasks but don’t engage with a professional bookkeeper because of cost. Businesses may overlook the need for professional help because they mistakenly believe they’re too small to justify the investment. While it may be tempting to hire a generalist bookkeeper, these hires are rarely licensed or equipped to deal with complex accounting issues, especially regarding taxes. 

Everybody makes mistakes, but as a small business, you can’t afford to make mistakes regarding your finances. Luckily, these accounting mistakes are easy to avoid with the right team and tools. Speak with LedgerFi and get things right – the first time.

This blog was created in partnership with LedgerFi, a bookkeeping and tax service solution for small to medium businesses. Learn more about LedgerFi. Get a team of professionals to handle the books while your business can focus on what truly matters.