I think you will agree with me when I say that getting on top of your expenses at tax time can be stressful!
Especially if you have a shoebox full of receipts.
You know those thermal ones you can hardly read that need data entry.
That was me.
Until I found a better way.
Well, it turns out that you can dramatically streamline the process by following a few easy tips.
1. Spending Money – Expenses [The Nuts and Bolts of Buying Stuff]
You will incur expenses when you’re running your business and you should keep a record of these.
Turns out that you don’t actually need those original faded receipts I was talking about. No, the ATO and the IRS have moved with the times and will accept electronic scanned copies of your original documents.
What type of records should you keep for IRS? Which supporting business documents should you hold on to for the ATO?
Supporting documents for your business expenses could include tax invoices, sales slips, paid bills, invoices and receipts. These documents contain the information you need to verify the records in your books.
In Australia, you will need a copy of your business expenses costing more than $82.50 including goods and services tax (GST).
Check out our guide on documents to get the full low down.
Here’s the deal:
Just make sure you have a backup of the digital versions. Using something like Google Drive or Dropbox makes that job pretty easy.
But here’s the catch:
Before you convert all your invoices and receipts into digital format…
Have a system
How do you make sure that you have captured ALL your receipts?
What is your process for cross-checking? Are you filing your emails with attached invoices after saving a digital copy of the invoice? Do you have a folder where all receipts are kept before scanning?
Decide will you scan or use your phone to photograph? Or both? There are also some great phone apps that allow you to convert a photo into a PDF.
Where will the digital receipts be stored? In a cloud accounting system like Uwazi or on your hard drive?
It’s great to hope for the best but be prepared for the worst when it comes to backing up your data! You can find out more about record keeping here.
“How long do I need to keep my records?” I hear you asking…
In Australia it’s pretty simple. The ATO requires you to keep originals or scanned originals for 5 years.
The IRS not quite so simple.
The Period of Limitations that apply to income tax returns varies depending on what the documentation is supporting.
Why do we need this?
To figure out the profitability of your business (determine if you are actually MAKING money) you need to track your business expenses.
How do I know if it’s a tax write-off?
You can claim a deduction for most expenses you incur in running your business as long as they are directly related to earning your income. Deductions can be claimed in the income tax return for your business entity or, if you’re a sole trader, in your personal tax return.
2. Methods of Payment for Expenses
This may be for small payments or for suppliers that do not accept any other payment.
Honestly, you should try to avoid cash payments if possible, even though is sounds so simple, paying by cash can actually create extra work for you afterwards!
Using your bank account to pay for business related items means you can track the payments and reconcile even if you have lost an invoice, the payment will appear in your banking records.
Paying by cash means that you will need to take the cash from your business bank account or use your personal cash, which means more record keeping is required.
For record keeping you also need to keep a copy of the invoice / receipt. You will need to make sure you include this in your expenses for tax write-offs as cash payments can be easy to forget to include.
Credit Card Payments
A really handy way of clocking up business expenses is by having a business credit card!
This allows you to be able to pay for many expenses quickly. This is an advantage as you are not always going to want to wait 3 days for funds to clear through to your supplier. You can pay online for goods and services, in person with your credit card, or even by providing your credit card details over the phone.
Wonderful thing about your credit card is that is comes with a transaction list of your business expenses with dates and even exchange rates for foreign currency purchases. You wont be wondering where all your money went – as can be the case with cash!
Use your statements and transaction lists to monitor your credit card for any unauthorised transactions. This is actually more common than you might think and these transactions can often be covered by the credit card insurance.
In the case of disputed transactions, raise the issue with your supplier first and then with your credit card supplier.
Another bonus: You don’t have to “pay” for expenses right away. Let the credit card company pay now and you can “defer” payment by paying off your credit card balance each month to avoid paying any interest!
Can you tell I like credit cards? When used the right way, can be a great tool for your business.
But: Only provide your credit card details to a trusted supplier. Suppliers will keep your details on record. You can find out more about credit and procurement cards here.
Does anyone still pay this way?
Very occasionally in Australia and with decreasing frequency in the US, you may need to pay by cheque/check. Make sure you put all the details on the butt for future reference.
Make sure: The funds are available when the cheque/check eventually does banked. Don’t forget those unbanked cheques/checks!
Again, have a system for recording when cheques/checks are written and then cashed. You can also cancel a cheque/check if required.
3. Goods or Services provided on Account / Payment Terms
Who likes to receive items before even paying?
I certainly do.
Some business will allow your goods or services to be provided in advance of payment. This is great for your cashflow as it may allow you to buy supplies for work that you are also not immediately paid for.
However: You need to be aware of some the issues that can be created:
While it is wonderful that you have received something for nothing, just remember that nothing is actually free! You need to ensure that you have sufficient cash when the invoice is due. This can be a trap for young players!
Have you received the correct thing?
Before paying you will need to confirm that the goods and services have been supplied correctly BEFORE you pay the invoice. It’s always easier to sort this out right prior to paying than chasing after a refund afterwards.
Checking you have been supplied correctly can become an issue for you when you have more than one invoice as there becomes a risk of duplicate charges or short supply.
I know right – there’s a tendency we can all have to check our invoice quite closely if you have to pay for the goods immediately…
When your payment is deferred, there is a temptation to check the invoice later.
Don’t get into the habit of doing that because it can become a problem:
For example: If you have opened deliveries and taken out items before checking what was actually delivered against the invoice details. Items can get mixed up from different deliveries.
Expenses Best Practice
Here’s the thing: You want to have a system (there’s that word again) to check any invoices as soon as possible.
AND if you do not agree with the invoice you need to contact your supplier as soon as possible to resolve the issue.
You ALSO need to KEEP TRACK of what you may have ordered on account.
Not every supplier will be efficient at sending invoices.
Do not assume anything!
If your supplier missed sending you an invoice together with the goods or providing the service – don’t assume that it will not eventually arrive at a later date.
Some suppliers send out invoices weeks or even months after supplying the services!
If this happens to you, some options are:
- ask the supplier to send you an updated statement (but again if they have not yet created their invoice it may not be included yet on your statement)
- ask the supplier to supply an invoice (but they still may not send one immediately)
- wait, and keep your own records of what has been supplied to you (take pictures on your phone which will include the time & date stamp) and how much it should cost so that when the invoice arrives, you are able to make sure it is correct
- keep a note of the price so that you know what cash you need to have on hand and you are ready to pay this invoice when it finally does arrive
4. Personal Expenses
What do you do when you use the business bank account to buy something completely unrelated to your business? Or you pick up a few personal items from the same store as a couple of things for the business….
How do you track these mixed expenses?
Total up how much is personal and how much is for the business. Next, split the classification of this transaction between the expense for the business and the personal spending.
Remember: You can’t claim your personal expenses a business deduction and you can’t claim back any sales tax for the portion of the purchase which was a personal expense.
If you are using an accounting system the personal amount would be coded to Owners Drawings.
Phew! Glad we got through that bit…
It was getting personal.
5. Supplier Credits
Ok, so sometimes you buy something for the business and then for whatever reason, you return the items.
Some suppliers will issue you a credit note rather than giving you a refund. So you have paid money and have nothing to show for it…
Except the credit note.
So how does it work exactly?
The credit note will then be used to offset against future invoices from the supplier. If you are using an accounting system, you can apply this credit to other outstanding invoices.
You can spend next time and not have to pay so much!
6. Inventory / Stock
What are the 2 ways that cause funds to flow out of your business?
The first is money spent on purchasing items for resale (that’s your stock) and the second is your regular business expenses.
Why does this matter?
Well, they are both things you need to spend money on…
But they are viewed differently from an accounting perspective.
Do you purchase and hold a considerable amount of stock that is then onsold? You should be considering if you need to be holding inventory and completing stocktakes.
Does your business buy stationary or supplies that are used fairly quickly? Indirect costs of running a business such as rent, motor vehicle expenses, electricity bills? These items can be treated as an expense of your business.
7. Asset Purchases
So we’ve covered the types of expenses required for the day-to-day functioning of a buinsess otherwise known as operating expenses (OPEX).
In contrast to this, expenses incurred by a business to create a benefit for the future are known as capital expenses (CAPEX or CAP).
Capital expenses are the purchases of assets.
An asset is an economic resource that is owned by a person or entity. For small business generally, it will be a purchase of equipment that benefits the business over a number of years, for example, new buildings, upgrades to existing facilities or purchase of a motor vehicle.
Normally the asset will then have its value reduced over the term of its effective life (the value of the assets is progressively written down) until its value is zero.
What does this mean?
Capital expenses will appear as assets on a company’s balance sheet rather than expenses on your profit and loss (P&L) statement otherwise known as income statement.
The asset is depreciated over the life of asset. A period depreciation expense is charged (usually monthly) to your income or P&L statement.
Your accumulated depreciation will appear on your company’s balance sheet as the sum of all depreciated expenses reducing the value of the asset over its useful life.
Currently, the ATO provides for simplified depreciation rules for small businesses (if turnover is less than $10 million). This means that if you purchase an asset that costs less than $20,000 you are able to write off the cost of the asset immediately.
Why is this good?
This will reduce your income in the financial year the asset was purchased.
Having a lower income means you pax less tax!
Seek advice from your accountant (or the ATO/IRS) to ensure you treat assets correctly for tax purposes and the current rules in this area.