It’s true: There aren’t many small business owners who want to spend more time dealing with business finances. But you have to dedicate the necessary time to expense tracking if you want to steer clear of costly pitfalls. You’ll avoid fines from the IRS, predict cash shortfalls, and what’s more exciting, understand when to grow, spend or save.
Expense tracking is a little more complicated than hanging onto receipts. Don’t worry—this article walks you through 9 things you should do to track your business expenses successfully.
1. Open a business bank account.
It’s highly recommended (and in some cases legally required) to keep your business finances separate from your personal finances.
If your business is one of the 23 million sole proprietorships in the U.S.—the most common type of business organization—you aren’t required to keep business expenses in a separate bank account, but it makes expense tracking much easier. For one thing, you’re less likely to do your taxes incorrectly or overspend.
If your business is a limited liability company (LLC) or a corporation, you’re required to open a business bank account.
Start by comparing business account options. Monthly fees, transaction fees and convenience will vary, and some banks even offer signup bonuses and other helpful financial services.
To open a business bank account, you’ll likely need the following:
- Doing business as (DBA) name
- Employer Identification Number (EIN)
- Social Security number (SSN)
- Organizing documents (e.g., Articles of Incorporation or Articles of Organization)
- Business license
If you don’t already have one, consider getting a business credit card too. You’ll build credit on a regular basis and access rewards programs created with businesses in mind.
2. Digitize your receipts.
You might not have a shoebox of receipts, as the cliché goes, but are you organizing your receipts the best way possible? Accurate bookkeeping, accounting and tax filing depend on it.
While you can keep physical copies of your receipts as a backup, you’ll get more protection and less hassle if you use digital receipts. There are several ways to start:
- Scan paper receipts and keep them on your computer or upload them to a cloud-based system like Google Drive.
- Use a receipt tracking app. With Expensify, for example, you simply take a picture of the receipt or type in transaction details.
- If you have a POS system that sends customers e-receipts, you should already have digital versions.
You’ll want to save receipts for at least three years—that’s the typical look-back period for an IRS audit—and you don’t have to save receipts for business expenses under $75. As you’re learning how to track business expenses, you’ll see why receipt tracking is so important.
3. Choose a bookkeeping system.
Simply put, bookkeeping is the process of recording and organizing your financial transactions—making sure records are accurate and up to date. On a regular basis, you want to be able to answer: What is your cash position?
It’s important to recognize that bookkeeping and accounting are different. Accounting involves similar tasks but has more to do with analyzing business finances and strategic planning than handling expense reports.
How should you manage your books? Here are some options:
Learn the basics using a beginner’s bookkeeping tutorial, then grab a ledger notebook and pencil, and record daily transactions. Review your receipts on a monthly basis and create necessary statements and reports.
Small business owners get a lot of value from bookkeeping software. You can sync your books with your business bank account or credit card so transactions are added automatically and take care of multiple jobs: receipt tracking, custom reporting and more.
Hire a bookkeeper
A bookkeeper will take care of the tasks we’ve mentioned and may also handle invoicing, pay bills and run payroll.
4. Decide on your business accounting method.
Your accounting method plays a big role in how your taxes are prepared and how you’ll track income and expenses on financial statements. There are two main types of business accounting methods, and although the cash method is the most popular, both have benefits.
Cash method (or cash-basis accounting)
Most small business owners use the cash method, in which you record income when you receive payment and record expenses when they are paid. In terms of record keeping, it’s easier than the accrual method. One downside, however, is that you get a delayed idea of profitability by month.
For example, let’s say you complete more jobs in October and fewer jobs in November, but don’t receive payment for your October jobs until November. Down the road, it may seem like November was more successful than it was in reality.
Accrual method (or accrual-basis accounting)
With the accrual method, you record income when it’s earned and record expenses when they’re incurred. Using the above example, you can already see one benefit to the accrual method. October gets the credit for the October jobs you completed. A drawback is that the month’s income statement (profits vs. losses) might look solid, when you may not have been paid for the job yet.
5. Use accounting software.
There’s a reason more than half of small businesses use accounting software to track expenses. It’s a user-friendly way to monitor cash flow and create a budget. It’s also more accurate than notebooks and spreadsheets—you don’t want to make a tax mistake because of a smudged number.
Here are some other benefits:
- Track and view payables and receivables from a mobile app or laptop.
- Pull in-depth financial reports on your own at any time.
- Guard records with password protection and encryption.
A lot of accounting software actually includes bookkeeping features, too, such as QuickBooks, Xero, FreshBooks and more. Maybe you had an accountant when you were first forming your business or still turn to an accountant for quarterly reviews. Pick an accounting software tool you like and use it yourself, or hand the reins to your accountant.
6. Keep track of your business expenses.
This step may sound redundant, but knowing how to track business expenses means knowing which expenses the IRS pays special attention to. The IRS specifically looks for irregularities with expenses and deductions related to:
- Your vehicle
- Business travel
You don’t need to keep receipts for business expenses less than $75, but we recommend recording the details of any purchases that fall into the categories above, regardless of their cost. You should at least note the time and place of the transaction, the business purpose of the expense and the names of people involved in the transaction.
7. Understand your tax requirements.
Similar to business bank account requirements, there are different tax requirements for sole proprietorships (self-employed business owners) and the various kinds of corporations.
If you’re a sole proprietor, you’ll report business income and losses on your personal income tax return and be taxed at the current individual rate. You’ll also pay self-employment taxes.
It gets more complicated for businesses that are organized as corporations, especially with ongoing changes to tax laws at the state and federal level. Make sure you understand your tax rate, the IRS forms you need to use, shareholder tax payment requirements and similar tax filing requirements.
In one survey, 40% of small business owners said they spend over 80 hours per year on tax preparation. Luckily, when you understand how to track business expenses correctly, you’ll save some time on tax filing.
8. Claim your small business tax deductions.
Although tax preparation can be stressful, this is one area where you’ve got a lot of control. As a small or mid-sized business owner, it pays to know which expenses are tax deductible so you don’t overlook savings.
Once you know the available small business tax deductions, you can make casual changes, like turning some regular business meetings into lunch meetings, to save money. As usual, detailed record-keeping is your friend.
You should also look for tax breaks specific to your industry—see this example for thrift stores—to transform tax time into money-saving time.
Examples of small business tax deductions
- Advertising and promotional deductions
- Charitable deductions
- Business meal deductions
- Education expenses
- Business insurance deductions
- Equipment or depreciation deductions
- Legal and professional fee deductions
9. Set up payroll and withhold the right taxes.
Payroll is one of the biggest business costs, so we’ve got to mention it if we’re talking about expense management. When and how you withdraw payroll taxes depends on your payroll frequency, your employee types and the system you use.
In most cases, you’re required to withhold federal income tax, Medicare and Social Security taxes, and state and local taxes—and it can get confusing quickly. If you don’t use a full-service payroll software to pay your employees, be sure to have a professional review your taxes.
The bottom line
Use these nine steps to start tracking expenses more thoroughly and get a better picture of your financial health. It’s always a safe bet to consult a certified public accountant, bookkeeper or other financial advisor if you’re doing any of the above steps for the first time. Finally, don’t forget to talk to your payment processor about ways to save on expense tracking tools made for your business type.