Ideally, every business begins by putting some basic processes and structures into place that ensure legal compliance and set you up for long-term success. In practice, so many new organizations start from a less stable place. It’s not uncommon for a business to start growing from someone’s garage, or maybe the founder just doesn’t have the capacity to look into all the administrative details – resulting in costly mistakes.
Unfortunately, inadequate setup can create some major headaches down the road. Here are the biggest (and most easily prevented) legal and accounting mistakes we see new businesses making.
- The legal structure doesn’t fit the business. A lot of people think that LLC is the best legal designation for the businesses, only to find out that they can’t pay themselves on a W2. Another common mistake: forgetting to account for self-employment taxes when operating as an LLC or failing to realize that an S-corp paying distributions needs to do so according to each shareholder’s percentage of ownership. How to avoid it: When you create your business plan, be sure to thoroughly research your options and choose the right legal structure—not just for your present-day needs, but one that will also accommodate your business as it grows.
- The business doesn’t have its own bank account. So many business owners start out by putting business revenue into their personal checking accounts. It’s an easy mistake to make because it seems harmless at the time—after all, you’re just starting out. Why do you need to make things complicated with an extra account? Unfortunately, commingling your personal and business funds can have major implications. It’s too easy to misclassify income and expenses, and it also voids the liability protection offered by setting up a separate legal entity. If your business finds itself in a lawsuit, your personal assets could be implicated by mixing your funds. How to avoid it: Open a business bank account and credit card right from day one.
- Business books are kept in an Excel spreadsheet. This is another one of those mistakes that seems harmless at the outset. You’re just getting started, not even sure if your business will take off. Why invest in accounting software? For one thing, doing everything manually in a spreadsheet leaves a whole lot of room for error, and that’s assuming you keep up with your bookkeeping. Many people find these manual processes so frustrating and annoying that they fall behind. At some point, the books are a huge mess and it all comes to a head. Whether it’s tax time, a fundraising round, or a need to identify where you’re losing money—it’s never the right time to be faced with an accounting backlog. How to avoid it: Choose an accounting software package that will grow with your business. On day one, you probably just need the basics. But eventually, you may need to add on payroll, payment processing, expense reporting, bill pay, and lots of other specific features. Xero’s cloud accounting software offers everything you need to get started and a user-friendly suite of add-ons when you need them.
- Not paying quarterly taxes. People who are new to running a business, or even having a side gig, often fail to think about taxes until they’re filing their returns. Guess what: taxes aren’t automatically withheld from your business revenue, and the IRS requires you to make regular payments throughout the year. If you come up with a significant shortage at the end of the year, you may owe hefty penalties and interest. How to avoid it: Almost any bookkeeping software will track your revenue and expenses and help you figure out how much you owe in taxes. When in doubt, talk with a CPA.
- Failing to collect and remit sales tax. If you sell physical goods, you almost certainly need to collect sales tax and remit it to your state. For online businesses, this can get pretty complex—do you collect taxes based on your home state, your customer’s state, or both? Certain services also require sales tax if they deal with the purchase of a physical item (for example, furniture delivery). How to avoid it: The way you handle sales tax is going to vary from state to state. Be sure to familiarize yourself with your state’s requirements as they relate to your business, and go from there. Above all, don’t ignore the need to collect and remit sales tax. It will catch up with you eventually!
- Not creating an operating agreement or corporate bylaws at the outset. An operating agreement clearly explains how the company will carry out its business obligations, as well as rules and responsibilities for the owners. It’s a legal document that will be in force should the owners have legal disagreements, and not having an operating agreement will subject your business to your state’s default rules should a situation go to court. While it may seem impossible when you’re just starting your business, founder disagreements become incredibly common as time passes and the business grows. How to avoid it: Work with your partners to create an operating agreement or corporate bylaws when you establish your legal structure. Once the operating agreement is in place, expectations are clear and your business will be stronger.
- Failing to keep good records, including a mileage log. When it comes to running your business, keeping good records is critical. There are lots of different things you’ll need to quickly reference over time—perhaps few more important than financial matters referenced on your tax returns. Business mileage logs are one of the most commonly overlooked records that get businesses into tax trouble. How to avoid it: Choose an accounting software that will keep track of everything you do throughout the year—and use it! If your software isn’t easy to use, it’s more likely to go untouched, no matter how good your intentions are at the outset. When it comes to logging mileage, use a convenient app to keep you in compliance. We recommend MileIQ to our customers.
Looking for a quick and easy way to brush up on accounting basics (and avoid these mistakes)? Check out our online bookkeeping for small business course, 5 Weeks to Better Bookkeeping. It’s totally free to small business owners and designed to help you understand accountant-speak.
Don’t let your business be derailed by simple accounting mistakes that are so easy to prevent. We know most business owners don’t want to be caught up in the weeds with accounting and legal requirements—you started a business because you’re passionate about your product, service, or major problem you want to solve.
We’re passionate about enabling businesses to grow through sound accounting practices and business insights. That’s why we created the Business Start-up Checklist—your definitive guide to all the big and little things you need to do before you open your doors. By putting the effort into setting yourself up for success from the start, you keep your focus on the things you love.
Better Bookkeeping for Small Businesses in 5 Weeks
Our online bookkeeping course includes a series of videos covering the basics of bookkeeping, as well as a variety of topics that are common struggles for small business owners. It goes into much more detail than we can in a blog post to help you address bookkeeping mistakes, and it’s totally free for small business owners. Sign up today and start your better bookkeeping journey.