What are some bookkeeping red flags to watch out for? First, you want to run a profit and loss statement by month—January, February, March, April, however many months you're looking at—in separate columns. You want to notice trends. Inconsistent trends mean you're likely not categorizing your expenses consistently the same way.
For example, let's say I purchase supplies on Amazon.com, so it's office supplies. Then, let's say I buy computer equipment on Amazon. What happens if I book that to office supplies when it really should be equipment? What my books will show is maybe there's one month where office supplies is a lot higher, and maybe there's a month where office supplies doesn't exist at all. Inconsistent trends are a flag to look out for because it means you can't make informed business decisions based on the numbers—they're just not in the right spot.
On your balance sheet, that's where your loan amounts, if you have any business loans, are listed. If you have the same loan balance from last year to this year, that's a red flag. It means you're not capturing your interest expense properly, which means you're paying more in taxes. It also means you can't see the trend of when that loan will actually be paid off. For example, if in 2022 my loan balance is $10,000 and in 2023 it also says $10,000, but I've been making payments the whole time, that's likely not the real outcome. My bookkeeping needs to be updated.
If I see a lot of credit cards on a small business owner's books, that's a red flag because chances are many of those credit cards are really just for personal use. You want to keep all personal transactions off of your books. I should not have a personal credit card that I'm tracking on my books. I don't need to be tracking my grocery store purchases or my food at home on my books. I don't need to track my mortgage statement or my primary residence on my books. If you want to keep track of your personal information, that's awesome—but do that in a separate file. Don't co-mingle your business transactions with your personal transactions.
In general, if I see an account that is a negative number on either my profit and loss statement or my balance sheet, that typically is a flag. Very few accounts should be negative. For example, if I have an expense item on my profit and loss statement that's a negative number, what that actually means is that I have some income wrapped up in there, which again means I can't use my financials to make informed business decisions because they're not accurate.
The last one I'll share, which is a really good foundational way to avoid a lot of these issues, is reconciliation. That's a fancy accounting term that really just means matching. You're going to match what happened in real life on your bank statement and your credit card statement to what is entered into the accounting software. It's literally just a matching process.
But I can tell you, we do hundreds and hundreds of books a month, and if they're not matching, you have transactions in there that have been double counted, transactions that are missing, and if you're using the download transaction feature, sometimes that feature doesn't get all the data. So again, your books are not accurate. You aren't able to use the financials the way you should to make informed decisions about how your business is trending. Maybe you're missing revenue or expenses. All of those things don't bode well if you're trying to look at the financials to see where you are, if you're hitting your goals, if you're going to be profitable, or if your cash flow is going to run short.
Doing the reconciliation process—matching what happened in real life to what's in the software—is one of the most critical steps of bookkeeping. Those are the red flags that I wanted to share with you. And remember, the IRS sucks.
