Bookkeeping Basics for Small Business Owners (Avoid These Mistakes)
Hey guys, it's Toby Mathis, and I'm joined by none other than Troy Butler. And we're going to be talking about bookkeeping today. Specifically, we're going to dove into the most common mistakes that people make when they're setting up a company or even running their investments. And so first off. Hey, Troy.
Hey, Toby. How are you? I'm doing absolutely fantastic. And hopefully everybody out there is to but let's dove right on in because we want to get right into the content. So what is bookkeeping at its most basic? It's recordkeeping, just keeping track of all your income and expenses.
That a company may have in. What does the IRS require? Like, what does that mean to the to somebody sitting out there? Like, what does that mean to somebody? What records do you have to keep? So the IRS is not very specific as they usually aren't, and they really don't have a whole lot of guidelines of what is bookkeeping I remember they had a webinar for professionals and they tried to pin him down. But we know it's like income. We know it's like expenses.
It's just what's required to keep all those things correct. Yeah. And there's thousands of different softwares that help you do it.
It can be as basic as Excel. It can be as complex as QuickBooks Enterprise. It cost thousands of dollars a license. But for most of our clients, there's a nice middle ground where we can find something that works for everybody. All right. What's the most popular or common software program? QuickBooks.
By far, QuickBooks is the gold standard and for a reason, they're very user friendly. Most people can figure out how to use QuickBooks, and if there's ever anything you can't figure out, there are thousands thousands and thousands and thousands of tutorials and classes you can take to teach you the basics. But at its most basic, because before we had QuickBooks, you still had to keep books. Yes. Now, and here's the thing I want to stress I don't care what kind of business you're in, you're required to keep books.
I don't care if you're sole proprietor partnership, S-Corp, C Corp, LLP, LLP. It does not matter. The IRS has the same requirement on all of those. Correct. Right. So, you know, so there's a misnomer out there that, hey, I set up a company and therefore now I have to do bookkeeping and you always have to do bookkeeping.
It's just monumentally more difficult if you don't have a separate structure. And one of the things that we see, for example, is the audit rates of Shopify orders are significantly higher than their corporate brethren. And the loss rate is about 95% when they do get audited because that are bad books. So let's break down bookkeeping into its little pieces. So I've heard of profit and loss. Most people have heard about count sheets and cash flow statements and all this.
What are the things that all companies really must have? So first and foremost, the two you mentioned profit loss statement, a balance sheet, general ledger, if you have those three, you're pretty well covered. And do I have to have like do I don't have to go into three different programs do I have to put it on three different excels or could I have one Excel sheet and in a good bookkeepers able to piece it out and put it into the into its form? Yeah, absolutely. You could definitely have one program or one Excel sheet to kind of keep track of it all.
And then, like you said, a good accountant can pass it out from there. So which of those three? So you said profit and loss balance sheet and General Ledger, what's the client going to be interacting with the most? Probably the profit loss. Okay. So explain to folks what a profit in losses. It's kind of what the name implies. It reports your profits and your losses.
It's also known as Income Statement. Yeah. It's your gross profit minus all of your expenses. Get to your net profit. All right.
So if I pay you $1,000 for services, that's going to show up as income. Income. Yeah. And then if while you're doing that, you have to pay for QuickBooks and you have to pay for a license and you have to pay for lunch what are those show up as expenses. All right.
So there's a big category of expenses. Perfect. And then the net is your is what your tax on is the difference between the two. All right.
What's the balance sheet? The balance sheet kind of shows all of your company's assets, its liability in your equity Okay. So those are big words. So let's go through those two. So back to your business. You buy a computer that's going to be an expense but also now you have a computer.
Is that an asset? Possibly. Possibly, possibly. Okay. But yeah, if you buy a piece of equipment. Yeah. That would probably be an asset.
All right. How about we'll go to our real estate investor? You our real estate investor buys a property. He can expense the property right. So you're going to it's going to go on a balance sheet.
On a balance sheet. But I know that the balance sheet interacts a little bit with that profitability. Sure does. How does it do it? Depreciation So then once we have an asset, we get to take a portion of it and move it over to the expenses and offset our income.
That's how those to interact. So I want to still break this down. Let's say I let's say again, it's your business. You're it's true. It's bookkeeping and you have a credit card.
Where does that show us going to show up is a liability on the balance sheet? All right. And then the specific items that you buy, those are going to be expenses on the profit must yet see how these things start interacting. These like everybody always thinks there's a balance sheet over here.
There's a profit and loss over here and that they have nothing to do with each other. No. All of these things interact and so you have your assets. Let's say that you have a house and it's worth 300,000 and you have a mortgage on that house that's going to show up as a liability. Right? Correct.
So the house is sitting there as an asset. Then you have a liability of a of a mortgage. And the difference between those, you said, is equity correct.
Which is basically like a fancy way of saying if it was an individual your net worth, but this is your company net worth. Yeah, exactly. And like the Webster's definition of that is if you sold all of your assets and paid off all your liabilities, this is what your equity is. What would be left. Yeah. And a lot of people skip that value of their company.
They're like, oh, my company is worth $1,000,000,000. They're just, you know, so they're trying to create assets. Like when you see a tech company, their assets as their intellectual property and they're just plucking stuff out of the air sometimes. Whereas if I buy something, it's really easy to say what it's worth. They'll let's be real. If I buy a house, it's not really what it's worth.
After ten years, that house can be worth a lot more. But on the balance sheet, that asset is going to look. It's going to be what you paid for it.
And then just the depreciation, lower it. Yes. Yep, yep. So you could end up with a balance sheet that looks pretty horrendous, right? But you actually have value and you have guys like Warren Buffett who are value investors that are experts at going on to balance sheets and figuring out what assets actually have value. But that's a topic for a different day. All right. So we have a profit and loss. We have a balance sheet.
And then the third one, what is this, General Ledger? General Ledger is just a listing of all the transactions that happens within your company in all the accounts. So if you ever see like an old movie where like the mob bosses have a book of all their transactions, that's the that's the general ledger and then they're taking that and making it into a PNL and a balance. Correct. Right. Right.
So from a client's perspective, if they don't want to learn bookkeeping, they could just keep a general ledger and hand it off to you. Yep. That would work. And then a good bookkeepers can be to take those items and place it on the right sheet.
And it's going to be to take the right like again, the way that you depreciate things we didn't know is the IRS says here's useful life you have. Let's say it's a computer, it's five years, and then you have things like sections that allow you to accelerate that into one year, like one 68 K and one 79. There's like some ways to accelerate that. But at the end of the day, there's a useful life of most items and that's what the bookkeepers are using generally. That's what you guys do. Yeah, absolutely.
And then you're able to say to somebody, Hey, get with your accountant to decide whether you want to go faster or slower, depending on what that panel is saying. Yep, that's exactly it. All right, so we've covered the basics. Profit and loss, balance sheet, general ledger, the profit and loss as items of income and expenses. The balance sheet is assets and liabilities, and the general ledger is every transaction. So from a client level that general Ledger is where you could just document every financial decision or everything you do.
And I shouldn't say decision, it's your transactions and you put it on general ledger and you hand it to a guy like Troy. They're going to be able to put together your books. Yep. Right. All right.
What are the most common mistakes now? Can we dove into that? Sure. Absolutely. Unless there's anything else you want to hit on this. I don't think so.
All right, let's go into the common mistakes then that we see. What do you see as some of the top mistakes? Yeah. This specific to our real estate investors when they set up a management company or really doesn't necessarily have to be real estate to be anything that has a management C Corp, they list out all the expenses for whatever they're managing on the sector rather than where it should be. So, like, they'll take the income and expenses of the rental property on the Sea Corp. and put it all on the books there. So really where you need to report the income and expenses is where the property is owned.
So if you have a holding company that owns a piece of real estate and in the renting that long term that real estate income and expenses need to be reported it with the holding company of the Sea Corp. Okay. I see what you're saying. So in the structure that Troy is referring to is typically you'll have somebody that has multiple real estate properties. They're generally held in LLC and that LLC is generally held by a holding LLC. From a bookkeeping standpoint, you probably keep that on one set of books, right? You have the holding and then you have each property LLC as a class exactly. Right. And you have that broken down.
So without getting into too specific, it means the way we structure is so that it's simpler on your bookkeeper. Now, a client may have a property management corporation that's receiving the rents and is in it is paying the net rents after it's covered all the repairs, the, you know, covers expenses on behalf of that property. Sometimes the corporation is writing it out on behalf of the holding company and the real estate company.
And the question is which return? Does that really go on? And if the property owner is the holding company, if I'm hearing you correctly, a lot of those expenses should be on the holding, even though it may have been written by the corporation on its behalf. Exactly. And so the way you do that is you make use of accounts called due to and do from. So basically one company owes another company money. So it's an asset on the company that to do the money. And so liability on the company that owes the money.
And I'm just going to stop it right here because some people's heads explode. Okay. And we're just going to say, General Ledger, remember, profit and loss balance sheet, General Ledger, if you can keep a general ledger of what an expense was paid, hey, I paid it out of this company and this is what it was for, then a bookkeeper can make sure it ends up on the right, on the on the right PNL and balance sheet. Correct. Because technically, if you have a remember that books and records are necessary of any investor so if you you have to keep books and records.
If it's an LLC has keeps books and records, right. You need to be to figure out what its income and expenses are, what its assets and liabilities are. So you could have a holding company that has 20 alleles underneath it. It's one set of books for that holding company because that's the ultimate taxpayer although you are tracking the expenses and everything by class, which means by property. So you can break out each property and say, this is what it's for.
And then if it's paying in working with a corporation, or if it's using a property manager corporation that you also own, you're going to keep a set of books on that and making sure that those to play well together for your benefit is something that is, you know, if you don't want to learn it, you bring in a guy like Troy and his team and they handle it. If you like to learn it, then you could absolutely spend the time. It's going to be how many hours do you think it would take somebody to learn a lot? What is a lot like 20 hours. 30 hours? Yeah, probably 20 to 30 hours. Yeah.
I always use the 20 hour to learn a skill. No. And now in our it's just making sure that it's going on the right or you just figure out how to keep your general ledger and then you hand it to a guy like Troy. And my personal view is that most investors time is better spent doing that. All you have to do is better track your transaction. Now, what if somebody is not going to sit there and keep a spreadsheet of their transactions? Then they can hire someone like me to do it for him. And what do you guys do when you do? You go to the bank accounts, credit cards and everything because we have all the trends.
Yeah. A lot of times what we like to do is we get what's called administrative access to a bank account or a credit card that allows us to see the transactions and that allows us to classify it doesn't allow us to move money around or anything like that. So there's no it doesn't.
Now, here's a rule of that. You should live by your being counter should not be your check writer. I'm just going to repeat that because this is how 99% of companies get ripped off being counted should not be taxed. Check writer. So Troy and his team might be able to see transactions but they can't write checks, correct? Nor should you ever have a situation because all it takes for a bookkeeper, if you haven't this hasn't occurred to you yet.
They could write a check to a company. They could set up their own company, pay it and call it an expense, and then your money's disappeared. Or they write it to cash, or they write it to a company but then cash the check in Vegas.
The casinos are kind of known for taking checks from just about anywhere. That's what usually happens. So I just put that as a time out. All right? So somebody can keep a general ledger. It may not even be. They have to do anything.
It may be that you simply give access to somebody to look at your transactions. And then what do you do? You ask them, what was this for? Exactly. Yeah. If there are transactions, we can't figure out what they are. We'll send you what we call our Ask My Countless.
So it's a list of all the transactions we're not sure on. Need some clarification? Okay. And that's fair. Yeah. All right. Know, I'm going to tell you guys a quick story, and then I'm going to ask more of the common mistakes. Like quick story was we went through a pandemic and there was this thing called P2P loans.
And economic injury, disaster loans or Eidl loans and different types of relief. In the first requirement on almost all of those was your PNL on your balance sheet from the previous year or your tax return, which might have balance sheets on it. Right. And either way, you needed to have books to qualify for any of these and we were sitting there and we were getting books that were on napkins. We were getting books that were scribbled out on a tablet paper where people were just kind of jotting things down. I think these were my expenses were that gets rejected.
Nobody's going to take that. The way you need to look at your books is what if the IRS or any third party lender walked in and looked over your shoulder and said, how is your company doing? It's like your vitals. It's no different than taking your pulse, taking your blood pressure and all those things.
For a person, maybe doing a blood test is you get it's just a bunch of numbers. You gotta have good books. If you're going to get loans, if you're going to get access to incentive, all sorts of different programs are generally conditioned on your ability to provide some sort of good record.
If you want solar credits, or any of that stuff, you need to have records of those transactions. All right. That set off my soapbox. What other common mistakes have you seen? The biggest one this happens all the time.
People try to overcomplicate it. It's not rocket science. We as accountants like to say cool phrases and cool words like debits and credits, but it's really not that complex.
But sometimes a debit to credit, the credit is a debit and sometimes a credit as a debit and a debit as a credit. They do goofy things that accounting like. They try to make it as difficult as possible.
So depending on where you're at, it might be a credit or it might be a debit. So don't do that. Yeah, right. Yeah. So the main thing that I would say to keep it simple is your chart of accounts. Keep a simple chart of accounts.
Not everything needs its own account. Combine things into one account when possible. Like so you don't need a McDonald's expense and or talk about expense use meals expense. It seems like common sense. You set chart of accounts. Yes.
In English what is a chart of accounts? A listing of all of the accounts that you can classify your transactions do. So it is it's here's all my deductions, right? Hey, maybe it's vehicles, maybe it's meals, maybe it's utilities, maybe it's computers or equipment. That's a chart of account. And what's a typical company? How many chart of accounts like how many items on a chart of account would you know, probably somewhere between 30 and 50 keep perfect. We understand what we're saying. There's literally here's what it could fall into.
There's maybe 30 or 40, 50 categories. If you're in a really complicated company, it's 50. If it's most I see are probably in the 20 to 30 range, you deal with a, you know, much more difficult. But a typical real estate investor, for example, how many items might be on a chart of account? 25. Yep. So you just have here's our here's where we could call this don't create a new expense item for everything correct? Absolutely.
You have meals and entertainment and no more entertainment but you have meals 50% of meals 100% you might have vehicles. What are there some common areas? Computers and equipment, small tools and repairs, office supplies, general supplies, repairs and maintenance, property taxes, licenses and fees. Yeah, that's a chart of accounts.
So whenever you hear an account and say, Oh, you know, this is your chart of accounts, what it is, is these are the categories things could fall into. It makes it much, much easier. Absolutely. Yeah.
We're not running Fortune 500 companies for the most part, so we don't need 200 page long chart of accounts. I've seen some nasty ones on my day. I've seen it. Yeah, I've seen them.
And it's like every item has a different thing and they want to call each bank you know? Hey, I have, I have ten bank accounts and they're all different. Like, you stop that. Like maybe on your balance sheet, you could break out your balances otherwise just call it checking.
You make it easy, they'll make it hard. All right, so people make it over complicated, right? What do you think? Why do you think they do that? They don't know what to do. Yeah. So when in doubt, call your accountant, call your bookkeeper.
And that feeds into my next step. My next step is don't guess if you're not sure on how to classify something use as my accountant as an expense type on your chart of accounts. And that allows us to have a discussion with you to figure out what this should actually go for.
Because what makes it difficult is when people guess in the guest wrong. We have to go through every single line item to make sure that, you know, everything's accounted for and I guess this is going to be one of my pet peeves. I used to have a thing called no journal entries. You'll have people that don't know what something is and they'll put it as a journal entry. Right? Or they'll just categorize a bunch of stuff that they don't know what it is, and they'll just make a single entry for all those things.
Don't do that right. Your general ledger put it on their if you don't know what something is, we say, put Amy next to it, ask my accountant and figure out how to categorize it where it goes appropriately. Because sometimes there's two or three places something could go. Absolutely. Yep. And we're saying, Well, if you put it here, here's the ramification put here, here's ramification. Sometimes it doesn't matter, right? Let's just be consistent this is where we're if we're going to have this type of expense over and over again, let's just figure out at the outset what we're where we're going to put it and then consistently put it there so that if you're ever using your books, which eventually you will, as you get bigger, you're going to use your books to make projections and to make financial decisions, you need to know that your expenses are you like, I can grab and say, this is how much I paid for my electric last year for my property taxes or for my insurance last year.
I need to be at a properly categorize them. It's almost impossible if you break them out and put them into different categories and constantly change it. Yep. And make a big mess of a chart of account. Yeah, be consistent. If you're going to be wrong, be consistently wrong.
Don't change it month by month. Yeah. And by the way, you just said something. If going to be wrong, be consistently wrong. That just means that it's easy to track. End of the day, pretend like you get taken off the earth and somebody needs to figure out what you did. You're just leaving a paper trail.
It's breadcrumbs and somebody needs to be able to see what you did. And if you misspelled something throughout a book, they can tell what you were doing. Even though you misspelled something or mis categorize something in your books, they could. They could still see what you were doing. What else, what other, what are their common areas of mistakes or what are the big tips? Yeah, another another big one is to make sure that you're submitting for reimbursement for things don't just if you're buying something personally, make sure you are submitting a reimbursement log so you're able to classify what those reimbursements are for. See that all the time where people just take out a distribution or repay their loans from a shareholder, but really they're just paying themselves back for something so they're not getting the credit that they're due yeah. Because if you reimburse for something, let's say I reimburse, for example, for a cell phone, that's an expense to the company, right? Depending on how you're set up.
If people are not categorizing that and they're just calling it a distribution act, which case you don't get an expense for it and you're going to pay tax on that. Right. And so if you're without repeating everything you said, make sure that if you are paying yourself for something, that expense that you incurred personally, for the business, that that business is noting it, taking it as an expense and that it's a reimbursement to you, it's an expense to the company. You're absolutely. All right. What else? Probably the last thing that I I'd say that we see a lot of people wait until the last minute to do their books.
They're not consistent with it. They don't do it once a month, once a week, once a quarter even. They wait until it's tax deadline time and try and figure it all out. Then the problem with that is memory fades I don't remember why I went to buy something off of Amazon April of last year, but if I had proper bookkeeping, good recordkeeping, I would be able to tell you that oh, that was for the supply that I bought in the IRS.
It once. What, who, what, where, when and why. Right. Regardless, even if you're doing meals and you don't have to keep a receipt, you still have to be able to prove meals under $75, by the way. But if, if I have an expense even for something that may not require the receipt, I still have to have, who was I with? Why did I meet, when did I meet, how much did I pay, you know, and, and what was the business purpose for that? Yep.
And within bookkeeping, most software is in Excel even you can put a memo of what it was that you purchased. So you're always able to pull back and remember what what it was that I bought or use one of these jobs and take picture receipt. Note Keep it in your calendar. A meeting, Troy for lunch.
And then if you see there was a there was a credit card statement, and I could see that I paid, you know, $20 for some sandwiches you'd be able to tie that in and say, Oh, I met with Troy. We had a business meeting about bookkeeping, and you'd get a 50% deduction for that. Right? Or is depending on the year. Yeah, it was that it was at 100. Is it still at 100. Still at 100 through the end of the year if it's through a restaurant.
And so if, if, if you make the sandwich you look. No, but if you go by, if you go to subway there's a free plug for some sandwiches please. Yeah. Yeah that's about right.
Then you could write off 100%. Even if you order from a restaurant you could absolutely 100%. But anyway, that's why it's so important. But Troy, you just inventively said as we might have two categories 50% deduction, hundred percent deduction in one year, the Subway sandwich may go in the 50% and then the next year, maybe 100%. You don't know any better if you just call it meals, you're going to miss out on a bunch of your deductions. And so that's why you end up working with good bookkeepers because they're worth their weight in gold.
Because they're going to make sure things are classified, right? You're going to get all the deductions you're entitled to. They're digging around, trying to see whether it was something was a reimbursement where you don't have to pay tax on it. Which could be a pretty big amount. Like how how big are we talking? Like, do you see people where it's thousands of dollars a year? Absolutely. Yeah, all the time. Yep.
And then just by that so like I say, it's three grand at my cost. That may have a net impact on them of over $1,000, which is silly because a bookkeeper is going to cost you a lot less right? So anything else, any less things that you want them to know? Yeah. Like I said, just keep it be consistent, make sure that you're keeping up to date with your books. Don't wait till the last minute. There's nothing worse than getting having to do a set of books in two weeks and then you're making mistakes trying to rush to get things done so you're consistent.
And then I'm going to say this before we, before we leave, if you have good books, your tax prep is easy. If you have a good balance sheet, how long does it take to do a corporate reach and not long. Not long at all. Like most of the time, people are doing return prep. What they're really doing is bookkeeping, right? And our tax repairs costs a lot more than our bookkeepers. Yep.
So is that the best use of your time is to either figure out what information you need to provide to good bookkeepers or set up a good chart of account for yourself and manage and discipline yourself and learn it so you're able to keep good books because it's going to save you hundreds of dollars per hour of somebody else trying to interpret it. If you could just hand your accountant a completed balance sheet and here's my piano and even here's my general ledger, like you give them those things and it's nice and crisp, they're able to take that information in very easily, create a tax return whereas if you didn't have that information, they're going to be spending their high dollar amount per hour churning away, trying to figure out what you did during the year and trying to guesstimate and reading tea leaves. And sometimes they just deny your expense outright.
They don't even tell you because you don't have backup in there. So I can include that. I can't include that.
And they don't really even let you know. And they'll just disregard it completely saying why we didn't have very good books. We didn't have a mileage log. So we didn't write off any mileage. You know, all those things really hit you pretty hard. Like, it costs you a lot of money, do good books.
The number one killer of businesses is running out of cash. The number one reason people run out of cash is because they don't understand the relationship between their income and their expenses. And their assets and their and their liabilities.
And they get themselves in a bad spot. If you have good books, you'll be at a C. Am I making money? I'm not losing money. Is my asset? Is my equity increasing my assets are growing faster than my liabilities, and you're able to look at things quickly.
If you have a general ledger, you can see the other expenses that normally I pay that I haven't paid. Yeah. Like sometimes this happens, you'll have a surprise, surprise, surprise. Six months, somebody hasn't paid a bill and all of a sudden you have it.
That that's why you get into a rhythm of seeing certain expenses. A good bookkeeper is going to say, Hey, I haven't seen your insurance expense in your properties, or We haven't paid property taxes. Last year it was $6,000. Where is it? And on that note, having good books allows for good tax planning as well, because you're able to know where you stand at all times so you can have a good idea of what you're going to find.
100% now. Good, better bass. Is it good to do quarterly taxes? It's good yes. Is it better to do monthly? Absolutely. And is it best to keep accurate books and records as you go along contemporaneously with all your expenses? Absolutely.
The majority of our clients can get away with monthly. But yeah, if you had an in-house bookkeeper that could give you a bookkeeping daily or weekly even, that would that would be best. All right. And that's it. If there's anything else, come to us. We're here for you. You got it.