Making the transition into entrepreneurship is new and exciting. After all, you probably dreamed about becoming your own boss and pursuing your business ideas. However, running a business is much different than being an employee of an organization.
One of the fundamentals of becoming a successful entrepreneur is understanding business expenses and accounting basics. In this article, we’ll explore both of these concepts in more detail, helping you solidify your accounting foundation.
Understanding business expenses
Business expenses are costs related to generating revenue. This could be raw materials that you turn into finished goods, business insurance, or wages. To be deductible, the cost must be directly connected to your business activities. This means that groceries for your family wouldn’t be a qualifying expense. Here is a list of qualifying business expenses:
| – Advertising – Bank charges – Interest expense – Licenses – Insurance | – Employee benefits – Wages – Travel – Taxes – Utilities | – Rent – Legal and professional fees – Depreciation – Repairs |
This list isn’t comprehensive, meaning you might incur qualifying expenses outside of this list. The industry you operate in will help you determine what expenses are deductible. For example, if you run a software startup, you most likely won’t be paying for raw materials.
Moreover, it’s crucial that you differentiate between business and personal expenses. When entrepreneurs first start out, they tend to comingle business and personal transactions. This can break your liability shield, putting your personal assets at risk if your business were to be sued.
Categorizing and tracking the cost-effectiveness of expenses
Expenses directly impact your bottom-line profitability, known as net income. This makes it important to properly categorize and track the cost-effectiveness of your business expenses. First, you should have a business bank account that houses all of your transactions. Most accounting software programs give you the ability to link your bank account, seamlessly flowing transactions into your ledger.
Next, you should retain the proper documentation for each expense. Many regulatory agencies will not accept bank statements as sufficient proof that the expense is qualifying. Instead, they need an invoice or receipt that outlines the cost and description of each item purchased. The more information you can store about your business expenses, the better.
Additionally, the information in your accounting system will help you track the cost-effectiveness of expenses. Maybe you find that you are overpaying for materials. Can you switch suppliers or negotiate a new vendor contract? With information at your fingertips, you can gather insights into profitability and where changes might be needed.
The main financial statements
The expenses of your business flow through to your financial statements. There are three main financial statements: the income statement, the balance sheet, and the statement of cash flow. Let’s explore each of these documents in more detail:
Income Statement
The income statement outlines the profitability of your company for a certain period of time. This report is where you will find all of your business expenses. There are a few main categories on the income statement, including:
- Revenue – This is the income your business generated for the period.
- Cost of goods sold – These are expenses directly related to your revenue, like direct labor in a manufacturing business.
- Selling – Selling expenses are costs associated with selling your product or service, like advertising and commissions.
- Occupancy – These are costs related to your physical location, like rent, building insurance, and repairs.
- General and administrative – This is the catch-all category of expenses. Common expenses found here include bank charges, office wages, general liability insurance, and employee benefits.
- Other income/expense – One-time or unusual transactions, like a government grant, will be found here.
The bottom of your income statement will show how profitable you were for the period.
Balance sheet
The balance sheet tracks your overall business financial health by outlining what you own, what you owe, and your past performance. Here are the main categories found on the balance sheet:
- Assets – Assets are everything you own, like cash, accounts receivable, inventory, prepaid expenses, and fixed assets.
- Liabilities – Liabilities include everything you owe to third parties, such as notes payable, wages payable, accounts payable, and credit cards payable.
- Equity – Equity houses everything you’ve contributed, withdrawn, and earned in the past.
The balance sheet follows the accounting formula, which outlines that assets must equal liabilities plus equity.
Statement of cash flow
The statement of cash flow tracks movements in your cash account. This statement includes three main sections:
- Cash flow from operations – Cash flow from operations takes your net income (profit for the period) and backs out changes between asset and liability accounts and removes non-cash transactions, like depreciation and amortization.
- Cash flow from investing – Cash flow from investing outlines changes in your fixed asset accounts.
- Cash flow from financing – Cash flow from financing holds all of your financing activities, such as loan payments, new loans taken out, owner contributions, and owner distributions.
Each of these three categories will contain transactions for the period, reconciling cash at the beginning of the period to your ending cash value.
Bookkeeping best practices
Part of generating accurate financial reports relies on strong bookkeeping controls. Here are some top tips and tricks to help you create accurate financial statements and accounting records:
#1 – Invest in software
Accounting software makes bookkeeping and expense management a breeze. For one, you should have an accounting software program that manages all transactions from your bank account. In addition, you should have expense-specific software, like N2F, to manage expense claims and vendors.
#2 – Regularly complete bookkeeping
Bookkeeping isn’t beneficial if you wait until year-end to get caught up. In fact, completing bookkeeping procedures, like monthly reconciliations, on a regular basis gives you important insights about growth and profitability. Make it a priority to regularly complete bookkeeping.
Maximizing efficiency and compliance
As an entrepreneur, accounting, bookkeeping, and expense management can seem overwhelming. Maintaining your accounting records relies on investing in the right resources, one of which is your expense reporting. Reach out to a team member at N2F today to learn more about how we can help you manage your expenses.
