The Internal Revenue Service (IRS) defines business expenses as the cost of carrying on a trade or business. We, as small business owners, may define it as all those things we hold onto receipts for, right? When you own and operate a small business, the finance department is likely a team of one and it’s likely you. You know how important it is to keep track of and record all those business expenses to prep for tax time. But the task of actually doing it or even feeling like you actually understand it may be a very different thing.
The first step to sorting and properly categorizing your business expenses is to create a process that works for you. When you have a process that makes sense to you, you are far more likely to keep up with it all year long. No more frantic spring sprint to tidy up the previous year’s records. Now let’s dive into why this really matters so much.
Benefits of Categorizing Expenses
Accurate Financial Records
When you keep your expenses and income properly categorized throughout the year, you will always have a clear picture of where your business stands financially. Maintaining accurate financial records helps with budgeting and forecasting future expenses. Categorizing throughout the year simply makes things easier for you. You will be much more likely to remember what a transaction was for three weeks ago, but maybe not so much if it was three months ago. Plus, you will save so much time compared to trying to get it all together at the end of the year. It’s stressful and overwhelming, and you really don’t need more stress. You will love the feeling of actually being prepared for tax season.
Improved Decision-Making
When you can easily see where your money is going, making important financial decisions becomes seamless. Keeping your expenses categorized throughout the year and keeping your books up to date allows you to see where your money is going and helps in identifying areas where you can cut costs or invest more resources. It provides a clearer understanding of where your money is being spent. This can be crucial when making decisions on so many things, from equipment purchases to which marketing avenue is giving you the best return on your money, and essentially everything else.
Tax Benefits
Proper expense categorization helps in identifying tax-deductible expenses, which helps in reducing your tax liability. In other words, you want to make sure every penny you spend to operate your business is accounted for and recorded. And on the off chance that you may be selected for an audit, accurate expense categorization makes it easier to provide documentation and evidence during the audit. Certainly, this may help in avoiding penalties and fines.
Types of Expense Categories
The expense categories you use for your business may differ from the basic expense list below. Although most businesses typically have expenses that fall into these categories. As you set up your categories, you can always create specific accounts that you want to see separated, even if they fall under one of these higher-level categories. For example, with marketing, you may want to see how much you spend with a particular source,, like Angi’s List or Thumbtack if you use their services to get leads and clients. Separating out your expenses can be very helpful when making decisions related to how and where you spend money.
- Office Supplies
- Job Supplies
- Software Subscriptions
- Professional Memberships
- Marketing/Advertising
- Legal/Professional Services
- Rent
- Utilities (phone, internet)
- Maintenance/Repairs
- Business Insurance
Of course all businesses are not created equal and your expense tracking needs may need to be a little more in depth. If you produce products to sale, you will need to track your Cost of Goods Sold (COGS) and inventory cost. Do you have a team on payroll? You will need to track those employee related expenses. If you have loans for your business, you need to track the portion of the payment made to principal differently than you track the portion for interest. Equipment purchases may fall under assets versus expenses, depending on the cost. These are a few examples of situations that will require a little more attention when properly categorizing.
It may seem complicated, but once you have a good system in place, monthly categorizing and reconciliation will be so much easier. Keeping track of all of your expenses throughout the year will keep you organized. You will also have an accurate picture of the financial health of your business all year long. Knowing your numbers is in effect knowing your business!
Need a hand sorting and categorizing your business expenses?
We can help with that. 🙂 Schedule your free, 30 minute strategy call today!