1. 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.
2. COMBINING PERSONAL AND BUSINESS FINANCES
It’s critical that personal and business finances be kept separate at all times, regardless of a company’s size. That’s why one of the first things new business owners should do is open a business checking account and deposit all business income into this account.
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 personal 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 personal financial strategy.
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