The issue of managing business expenses plagues many small businesses. In fact, the Federal Reserve Small Business Credit Survey unveiled that covering operating expenses emerged as the top financial obstacle. Alarmingly, nearly half of the business owners admitted they’d have to dip into personal resources should their revenue evaporate for two months.
Maintaining diligent records and analyzing expenses is a fundamental aspect of fiscal management. When executed correctly, it can greatly enhance a business’s odds of steering clear of such financial conundrums. Expense tracking enables a business to strategize better, foresee potential cash flow hiccups, and ensure that crucial expenses – like payroll – are promptly addressed.
Operating a business entails unavoidable and requisite costs, commonly known as business expenses. This includes expenses like inventory acquisition, payroll, and rent. These expenses, also denoted as deductions, are the essential costs involved in running a business. They are registered on the income statement. By deducting these expenses from the business revenue, a company’s net profit or loss, along with its taxable income, is determined.
Why is Expense Tracking Crucial?
According to the U.S. Small Business Administration (SBA), financial management encompasses bookkeeping, projections, financial statements, and financing. Core financial practices include devising a budget, securing reliable credit sources (ensuring some credit is always accessible), and maintaining a distinct bank account for payroll purposes.
A study conducted by the Federal Reserve Banks of Chicago and San Francisco established a direct link between robust financial management and the fiscal wellbeing of small businesses. Businesses with superior or exceptional financial health shared four characteristics: proficiency and experience with credit products, a surplus of unused credit balances, budgets that were regularly revised, and reserves for payroll.
Keeping a tab on business expenses aids a business in:
- Crafting a Budget: A budget is an organized outline of all monthly or yearly expenses, segregated by categories. To budget effectively, a business needs to be aware of its available funds, projected expenditures, and compare budgeted versus actual expenses.
- Leveraging Tax Deductions: According to the IRS, to qualify as deductible, business expenses need to be both ordinary and necessary. An ordinary expense is common and accepted in the specific trade or business, while a necessary expense is helpful and relevant to the trade or business. Most business expenses, given they’re substantiated with documentary proof (receipts and statements), can be fully or partially written-off, reducing the taxable business income.
- Managing and Optimizing Cash Flow: Regularly tracking and recording expenses according to the preferred accounting method of the company ensures sufficient cash is available for payments. It also aids in the responsible use of credit cards, credit lines, or loans to bridge shortfalls and optimizes favorable payment terms with suppliers to avail discounts and retain cash for longer.
- Identifying Outliers and Cost Savings: Plotting and routinely scrutinizing expenses allows business leaders to quickly detect unexpected cost hikes, evaluate their legitimacy, and tackle them – a straightforward strategy to reduce unnecessary costs.
- Benchmarking Against Other Industries: The U.S. Census Bureau provides industry, state, and region-specific data to help businesses assess if their expenses align with others in their industry. By tracking expenses, a business can regularly compare its data against industry standards and geographic averages to ensure its costs are reasonable and seek opportunities to reduce them.
- Guaranteeing PPP Loan Forgiveness: During the coronavirus pandemic, many small businesses benefitted from the Paycheck Protection Program (PPP) loans to manage slowdowns. This debt will be waived by the federal government if used to cover certain business expenses. Eligible business expenses include payroll, specific costs related to business mortgage interest, rent, leases, and utilities.
Video: How to Track Business Expenses
What’s the Optimal Approach to Track Small Business Expenses?
For precise expense tracking, every small business must incorporate bookkeeping – an organized approach defined by the SBA for recording all income and expense transactions.
In its manual form, expense tracking for a small business might unfold as follows: Throughout the week, the business owner amasses all expense-related documents, such as invoices, receipts, and credit slips. The bookkeeper then collates all these documents and inputs them into a preformatted Excel sheet, ensuring incoming cash is tallied and expenses are timely settled. The collated figures are utilized to generate various reports on at least a monthly basis. These include the income statement, balance sheet, cash flow statement, accounts payable report, accounts receivable report, and inventory report. Upon reviewing these reports, the business owner identifies any inconsistencies or potential improvements and implements the necessary adjustments.
However, even rudimentary small business accounting software can automate most of the processes described above. This software could potentially simplify the process by allowing business users to capture receipts using a smartphone camera and classify them into predetermined expense categories via optical character recognition (OCR) technology.
The selection from a multitude of accounting solutions can depend on the complexity of the business and the amount of revenue it generates. These solutions offer varying capabilities that streamline and automate accounting and financial management processes. Nonetheless, small businesses in their initial stages need to adhere to certain basic steps to ensure the data fed into the system, and the processes surrounding it, are reliable.
Seven-Step Guide to Effectively Track Small Business Expenses
To competently track and control expenses, leaders of small businesses should follow these steps:
- Initiate a Business Bank Account: The Federal Reserve study divulged that over 60% of financially healthy firms established a budget and a distinct bank account for payroll. This action was taken by less than 5% of financially struggling businesses.Creating a unique bank account for business expenses eases the tracking process and enables later tax deductions. The SBA highlights that business bank accounts offer personal liability protection by segregating business and personal funds. Additionally, they often come with a line of credit option, usable to buffer cash flow deficits.Businesses should consider opening a checking account, savings account, credit card account, and a merchant services account for accepting customer credit and debit card transactions. The business will require its Federal Employment Identification Number (EIN) to open a business bank account. For sole proprietors, their social security number is acceptable.
- Employ a Dedicated Business Credit Card: A business-specific credit card allows businesses to build a credit history, thus enabling them to secure optimal financing terms when required. Available credit is a significant indicator of overall financial health. The Federal Reserve study revealed that while 65% of financially challenged businesses reported no available credit, 87% and 95% of businesses with above-average and excellent financial health, respectively, had credit available. The SBA states that credit cards assist businesses in negotiating favorable terms with suppliers and offer protection against identity theft. Business or travel rewards are additional perks that credit cards provide.
- Select Cash or Accrual Accounting: All small businesses must choose a set of guidelines for reporting income and expenses, providing consistent accounting methodology for tax purposes. Small businesses with $25 million or less in annual gross receipts for the preceding three tax years can use either accrual or cash basis accounting (the previous limit was $5 million).Accrual accounting, being the recognized accounting method under Generally Accepted Accounting Principles (GAAP), is required by most private companies for financial reporting, barring a few exceptions.Cash basis accounting could be a simpler option for small businesses as it records transactions when payment is received, and expenses are deducted in the tax year they are paid. Accrual basis accounting records the transaction upon sale completion, allowing businesses to deduct it in the tax year incurred, regardless of payment timing. Accrual accounting requires double-entry bookkeeping and offers a more comprehensive and accurate financial picture due to its long-term business view.
- Opt for Accounting Software: Robert Half’s survey revealed that 58% of U.S. respondents’ companies use either some or only cloud-based solutions in their accounting and finance functions. Such solutions simplify the monitoring, organizing, and paying of expenses, ranging from supplier invoices to rent payments and payroll. They reduce the work needed to track expenses and enhance the accuracy of this information. Additionally, they offer reporting tools providing insight into expenditure on each category and year-over-year comparisons.
- Digitize Receipts with a Receipt Scanner: Some accounting software supports mobile apps that allow employees or business owners to scan receipts using their smartphone’s camera. However, a standalone receipt scanner lets organizations scan a document, review it, and categorize it, either auto-mapping the contents to predefined fields in the accounting software or manually. Desktop receipt scanners, starting as low as $100, are a wise investment for both expense and document management and can be easily integrated with most accounting software systems.
- Link your Bank Account to your Accounting Software: The level of integration a small business can enable with its bank depends on the chosen software. Businesses can download and manually import credit card and bank statements as CSV (Excel) files into the system. Most accounting software offers a connectivity plug-in providing a bank feed. This digital bridge between the bank account and accounting software imports bank transactions and statements daily. The business can configure matching rules in its system to reconcile the statements, optimizing the reconciliation process.Some accounting software offers direct integration with the bank, allowing the business owner to manage all banking within the accounting system, eliminating the need to separately log into the bank account portal.
- Frequently Review and Categorize Expenses: The more a small business scrutinizes its figures and comprehends them, the higher its likelihood of thriving and expanding. Business leaders need to grasp their organization’s current and near-term financial health, and frequent review of expenses and associated metrics is an integral part of that process.Small businesses face challenging odds. Pre-pandemic data shows that only about half of small business establishments survived for five years or longer, and just around a third endured for ten years. Nevertheless, their role in the health of the national economy is substantial and indispensable. Businesses with fewer than 500 employees contribute to nearly half of the private-sector workforce, and the SBA’s Office of Advocacy attributes 44% of U.S. economic activity to them.Tracking business expenses is a crucial initial step towards acquiring the data needed for not only better day-to-day or month-to-month management but enhanced long-term decision-making that will benefit employees, customers, and the entire economy.