The Ultimate Guide to Managing Small Business Expenses
How can small business owners properly manage their business expenses? Most small business owners are driven by skill and passion to open their business. Whether they are carpenters, auto mechanics, personal trainers, or photographers, small business owners all share a common bond of doing what they love – and excel at – for a living.
Unfortunately, another trait that they may share is uncertainty about how to manage the finances of their business. This uncertainty can have dire consequences, as poor financial management can quickly undermine whatever success a small business may have enjoyed and compromise its future. We have put together this guide to help small business owners manage their expenses with tips and advice you can follow to stay on top of your finances. Managing finances, along with skill and passion, is crucial in the business’ success.
How to Manage Small Business Finances
Managing small business expenses, of course, is a huge part of managing the finances of a business. So, what steps can be taken by small business owners who are not well-versed in financial management to ensure the financial health of their small business? How do small business owners manage money? What are typical small business expenses? And, just as importantly, how do you manage expenses?
Entrepreneurs typically work without a regular paycheck. This is especially true for owners of a startup business. As such, successful small business owners quickly learn to move money around more conservatively than those individuals who earn a steady paycheck.
But what are the best ways for business owners to stay on top of their finances? There are several basic ways this can be accomplished.
- Open a business bank account. For a variety of reasons, it is critical that business income is separated from personal finances. Keeping these two accounts apart can make keeping the business books easier and help budget for both business and personal finances. It is never a good idea to use personal savings, checking accounts, or credit cards for business expenses. Mixing funds between accounts can make for a complicated account and may invite IRS scrutiny. Determining which business bank account is best for a small business depends on factors, such as:
- Whether the business needs a business checking account or savings account;
- What, if any, monthly service fees are charged and if they can be waived;
- Transaction and cash deposit limits;
- ATM access;
- Wiring allowances;
- And online and mobile banking access.
- Use a Dedicated Business Credit Card. Using a dedicated business credit card is a natural way for a small business to establish credit and, when needed, qualify for financing with better financing terms. According to the Small Business Administration, credit cards can also help businesses receive more favorable agreements with suppliers. Credit cards can also help protect businesses from identity theft.
- Using Accounting Software. Many small business owners can struggle with managing small business expenses and business costs. A common mistake is trying to manage accounting records manually. Accounting software can change that; set up a bookkeeping system and store all the key documents of a small business electronically. As a result, the accounting of the small business is simplified, saving time and money.
- Get professional help. Small business owners who attempt to file their own taxes or manage their own books have been known to make expensive mistakes. While it is the nature of a small business owner to try to save money wherever possible, taking unnecessary accounting risks that can result in costly penalties may not be the most prudent course of action. Plus, using a paid tax preparer or tax planner can help pay for itself, since tax professionals can find deductions and other legitimate ways to limit the tax burden of a small business. Hiring professional tax preparers may help pay themselves by finding deductions and other legitimate ways to lighten the tax liability of a small business.
In addition to tax preparers and tax planners, other professionals who can help manage the finances of a small business are bookkeepers and certified public accountants (CPA). It is the responsibility of the bookkeeper to manage the day-to-day financial records of the business, manage accounts receivable and accounts payable, reconcile accounts and appropriately record and manage expenses. CPAs, meanwhile, can help ensure that a business stays within budget, prepare financial statements, and, if necessary, assist with external company audits.
A good resource for finding a CPA is the American Institute of Certified Public Accountants (www.AICPA.org), the professional organization of Certified Public Accountants in the U.S. with more than 428,000 members.
- Understand personal and business credit scores. It is almost inevitable that small business owners will need to access credit at some point. As a result, the ability of a business to qualify for financing will depend on the personal credit rating of the small business owner and the credit rating of the business itself. How well a small business is managing its finances will directly affect both of these scores.
- Research financing options and how to qualify for them. While credit scores are a key part of obtaining financing, it is important to note that all types of loans and every lender has varied eligibility requirements, such as annual revenue, how long the business has been operating, and credit scores.A budget does not need to be complex. Rather, it can simply be a rough overview of what amount of money is needed each month to cover both personal and business expenses. Once these amounts are determined, the next step is to attempt to cut costs wherever possible to invest back into the business or to save for the future. This is the profit of the business.
Another tip to manage small business income is to set aside a portion of the business profit to create an emergency fund. This fund can be used to help the business navigate slow periods or unexpected expenses.
- Budget for Taxes. Taxes are an ongoing expense for small business owners and are subject to a different tax structure. Funds need to be set aside for quarterly income tax payments on both the federal and state levels. Sole proprietors need to pay annual self-employment tax. Of course, state sales taxes must also be collected from customers and paid on a regular basis. While these amounts vary from year to year, it’s recommended that small business owners save approximately 35% of their income for taxes.
Managing Expenses for Small Business
Expenses are actually appealing to small business owners because they represent a way to minimize the tax liability of the business. You’ve probably heard about big companies that pay very little in taxes because of how they account for their expenses. But the benefits of business expenses can apply to small shops or large corporations.
But what exactly are small business expenses? Technically, business expenses are costs incurred during the ordinary operations of a business. They are subtracted from revenue to determine the taxable net income of a company, otherwise known as the company’s profit.
It is not unusual for novice small business owners to ask, “What are common small business expenses?” Another common question is “What expenses can I claim as a small business owner?” For entrepreneurs who need guidance in how to expense for their small business, some of the more common small business expenses include the following items. You can use this list to compare to your own business to see how many of these common expenses you already have, and which might be unique to your business.
- Health Insurance. Self-employed people are allowed to deduct up to 100% of payments. For high-deductible health plans, the self-employed can also contribute to a health savings account on a tax-deductible basis.
- Home Office Deduction. The self-employed can also qualify for significant tax breaks should they meet the IRS guidelines for operating a home office. Expenses such as painting or decorating an office, cleaning services for the portion of the home that is used for business, and insurance for business equipment are examples of expenses that are fully deductible. There are two ways to deduct home office expenses: the simplified method and the standard method. Under the simplified method, business owners can deduct $5 per square foot of their home that is used for business, up to a maximum of 300 sq. feet. The standard method allows business owners to multiply the sum of all the expenses of maintaining their home by the percentage of the home devoted to business use.
Rent, Mortgage, Utilities. The square footage of a home office must be calculated as a percentage of the entire home in order to determine how much can be deducted from rent, mortgage, utilities such as phone, electricity, water, and gas bills. Cell phones and their monthly bills are also fully deductible as business expenses when the cell phone is used exclusively for business purposes. The portion of internet service used for business is also fully deductible.
- Office Equipment. The purchase or rental and maintenance of computers, cell phones, printers, scanners are all considered small business expenses. Small businesses can elect to write off the full cost of any assets that cost less than $2,500 per item for the year that the items are purchased. The IRS also gives business owners other methods to write off the full cost of assets upfront in the first year.
- Depreciation refers to a method of quantifying how much an asset of a company wears down over a period of time. Depreciation expense is the amount that the assets of a company depreciated for a single period of time, such as a quarter or a year.
- Retirement Plans. Contributions to a variety of retirement plans, such as Simplified Employee Pensions (SEP), Individual Retirement Accounts (IRAs), and Keogh accounts.
- Auto Expenses. There are two ways to deduct the business use of a vehicle. The first and most common is to deduct the amount per mile that the Internal Revenue Service allows for business travel in a given year — in 2021, for instance. It is also possible to itemize a deduction for depreciation on the cost of your vehicle and add that amount to all the costs of running and maintaining a vehicle, such as insurance, gas, oil changes, registration fees, and the like.
- Entertainment. Fifty percent of business expenses are deductible if those expenses are necessary for entertaining a client, customer or employee provided it is directly related to the small business or associated with the business. Such instances need to be documented with receipts and the purpose of the meal or event.
- Business Travel. All expenses associated with overnight business trips may be deducted. These expenses include transportation, lodging, meals, tips, and phone calls. For trips that combine business and pleasure, travel and business expenses may only be deducted if more than 50% of the trip is for business purposes.
- Office Supplies. Pens, printer ink, legal pads, paper clips, file folders, printer paper, post-it notes, stationary, and many other office supplies are all deductible small business expenses, as is postage.
- Advertising, Public Relations, and Promotion. Any expenses associated with marketing your business are tax-deductible. These include websites, print and visual material, and the cost of hiring a R. firm and buying ad space.
- Bank Fees. Annual or monthly business credit card fees, transfer fees, or overdraft fees are all tax-deductible, as are the merchant and third-party processing fees charged by vendors such as Clover and PayPal.
- Any interest paid on a loan or credit card company to cover expenses is also a deductible business expense.
- Business Insurance. Premiums paid for any type of business insurance are deductible. This includes property coverage for equipment, furniture and buildings, liability, auto insurance for business vehicles, professional liability or malpractice coverage, workman’s compensation coverage, group health, dental and vision insurance, life insurance that covers employees as long as the business or business owner is not a beneficiary and business interruption insurance.
- Office Furniture. Filing cabinets, bookcases, chairs, tables, desks, lamps all qualify as small business expenses.
- Software Subscription. Any software – including accounting software – that a business purchases or downloads can be a deductible business expense.
- Any classes, workshops, seminars, or other event that adds value to a small business by increasing the expertise of the business owner is a deductible expense. Transportation to and from these events is also considered a business expense. The same is true of subscriptions to any trade or professional publications or books that can increase the knowledge, skills, and expertise of the business owner.
- First Year Expense Deduction. The expenses of startup businesses are capped at a $5,000 deduction in the first year if those expenses are $50,000 or less. Should startup expenses exceed $50,000, first-year expenses are reduced by the amount greater than $50,000.
If you’re worried about how to prepare expense statements for your IRS tax return, the IRS has a helpful IRS guide to business expenses that you can use when preparing your taxes. How Can Small Businesses Keep Track of Expenses?
Small business expenses should be placed in specific categories, as itemized above, and recorded on a regular basis. Depending on the type of business and how frequently business expenses are incurred, these expenses can be recorded daily, weekly, or monthly.
The plethora of expenses a small business can incur over the course of a year can be overwhelming and can cause many small business owners to ask, “How do you organize small business expenses?” Fortunately, when it comes to how to manage business expenses, the electronic age has made it easier than ever.
The first step is to digitize all receipts with a receipt scanner to maintain a permanent record of expenses. Accounting software, such as Quickbooks, can then categorize the expenses and keep them organized. Connecting the dedicated business bank account to the accounting software is an important move that can automatically create an updated record of all the transactions of the small business.
Small businesses should also choose cash or accrual accounting to help simplify tracking expenses. Every small business is required to choose a set of rules to report income and expenses for tax purposes. Small businesses with $25 million or less in annual gross receipts for the three prior tax years can use either accrual accounting or tax basis accounting.
Most private companies need to use accrual accounting since it is the recognized accounting method under generally accepted accounting principles (GAAP). But, because it records the transaction when payment is received, cash basis accounting can be more direct and easier to manage for small businesses. It allows expenses to be deducted in the year in which they are paid. Accrual accounting, on the other hand, requires double entries to be made. Since it looks beyond the given year and takes a long-term look at the business, it provides a more complete picture of the financial health of a business.
How to Calculate Small Business Expenses
After compiling a record of expenses, the next step is to calculate them. This involves figuring out how much a small business has spent in each category of expense. Since subtracting total expenses from revenue results in the taxable net income of a business, accuracy is paramount. There are two ways to calculate these amounts: manually and digitally.
- Manually Calculating Expenses. Even if a small business has digitized its receipts for safekeeping, it can still use the manual method of calculating expenses. Spreadsheets are a traditional way to way to do this, as are accounting ledgers. But using a process can be time-consuming and is more likely to result in errors.
- Digitally Calculating Expenses. Choosing the correct accounting software program can make the process of calculating expenses for a small business smoother and more accurate. Accounting software makes it easier to monitor, organize and pay expenses. It can also compile amounts spent on each individual category and compare amounts spent monthly or annually.
How to File Expenses for Small Business
After diligently tracking and calculating their small business expenses for the year, it is not uncommon for small business owners to then ask, “How do I file small business expenses?” The answer depends on the structure of the business.
Sole proprietors, for instance, must complete a Form 1040 Schedule C tax form – also known as Profit or Loss from Business – to file business expenses. This form is used to determine the taxable profit for a business in a given year. Part II of the form contains lines for categories for all types of business expenses. Partnerships, Limited Liability Corporations, and Corporations file their business expenses through a variety of different forms.
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