How to Track Business Expenses: The Ultimate Guide for Beginners
Making your small business profitable requires a constant balancing act. On one hand, you must focus on generating sales through your brick-and-mortar store, service business, or ecommerce platform. At the same time, you must also manage your expenses efficiently so that your business is profitable.
Accounting software provider FreshBooks notes that insufficient cash is a major cause of business failure. To avoid that unpleasant outcome, you need to aggressively focus on maximizing your income while consistently tracking business expenses.
If you’re just starting out, business expense tracking can seem to be a bit overwhelming. That’s why we’ve put together this practical guide that covers everything you need to know about business expenses and how to track them. Let’s take a look.
Definition of business expenses
The term “business expenses” aptly describes those costs that arise during ordinary business operations. This description applies to small businesses and large corporations alike.
For accounting purposes, business expenses appear on a company’s income statement. When business expenses are deducted from revenue, the result is the company’s taxable net income. Following are some common examples of business expenses:
- Advertising and marketing
- Bank charges
- Consultation costs
- Employee benefits
- Fees and subscriptions
- Office Supplies
- Rental expenses
- Utilities (electricity, phone, and internet)
Which expenses are tax-deductible?
If a business is in operation to generate a profit, a portion of the company’s expenses will be tax-deductible. When you claim a deductible expense, your taxable income is lowered, so you’ll pay less in taxes. However, it’s important to know which business expenses are fully tax-deductible or partially tax-deductible, and which aren’t eligible for deductions.
According to the Internal Revenue Service (IRS), a deductible business expense must be “ordinary and necessary.” Ordinary expenses are costs that are common to your trade or type of business. Necessary expenses are costs that are appropriate for the operation of that trade or business.
Fully tax-deductible expenses
- Business-related licensing fees
- Contract labor
- Electronics and software
- Employee wages
- Mileage (at standard mileage rate)
- Office fixtures and furniture
- Office supplies
- Professional and legal fees
- Research and development costs
- Rental expenses
- Travel expenses (doesn’t include daily commuting costs)
Partially tax-deductible expenses
- Business meals
- Vehicle expenses (based on a formula)
- Home office expenses (based on a formula)
- Business startup costs
- Business assets (also called capital assets)
- Sales tax
- Property improvements
Why should you track business expenses?
Every company benefits from consistently tracking business expenses. However, it’s especially important for budget-conscious freelancers and self-employed small business owners.
Regularly monitoring income and expenses enables you to obtain updated information about your business operations. Specifically, you’ll get a real-time snapshot of your purchases and other expenditures during a specific period. If you decide it’s necessary to decrease expenses, you’ll have a good baseline for those reductions.
Looking at the bigger picture, good expense records and financial reports can provide a picture of the financial health of your business. Based on that information, you can identify areas for improvement and/or growth.
How to easily track business expenses
Making a commitment to track business expenses means changing the way you approach your company’s operations. By putting a few key components in place, you’ll get a better picture of your finances and business profitability.
1. Set up a business bank account
It’s important to keep your business expenses and personal expenses separate. By taking that essential step, your business can stand as a distinct entity that’s separate from your personal finances.
Keeping a solvent business bank account will help to establish business credit, an advantage when applying for a business loan. In addition, your personal assets will be protected if an audit, lawsuit, or bankruptcy arises.
Opening a business bank account is simple and fast. Ideally, open this small business account at your current banking institution. This makes it easy to transfer funds from your personal checking account if necessary. Deposit all your business income into your business checking account.
Note that sole proprietors are not required to open a business bank account. However, business owners who form a limited liability company (LLC), partnership, or corporation must open a business account.
Company credit card
Your business bank account will likely come with a business credit card. By exclusively making business-related purchases with this card, you can easily track your business expenses. This is especially important when you’re preparing your records for tax season.
2. Choose an accounting method
For your accounting method, you can choose from two business accounting system models. Each system works best for specific types of businesses.
Cash accounting method
A cash accounting system is a good option for sole proprietors, freelancers, and very small businesses. Using this model, you’ll record income when you receive it. When you make a payment to a vendor or service provider, you immediately record it.
Accrual accounting method
An accrual accounting system is a better fit for businesses with employees, expanding businesses, and larger companies. Using this system, you record income when you sell a product, rather than when you receive payment for the sale.
So, when you receive a bill from a vendor or service provider, you immediately record that invoice. You don’t wait until you pay the bill to record that item.
3. Use expense trackers or receipt apps
Come tax time, you don’t want to be frantically gathering paper receipts before your appointment with your business accountant. To end this outdated (and maddening) practice, get an expense tracker app that will get your receipts under control.
This handy electronic tool is also called a receipt app, and it’s simple to use. So, when you purchase office supplies, for example, all you need to do is to take a photo of the receipt with your smartphone. Then, upload the transaction through the expense tracker app or via a text message. You’ll have an electronic record that won’t fade or become the victim of a coffee spill.
4. Choose your accounting tools
Time-saving electronic reporting tools can make laborious expense report compilation a thing of the past. However, a 2019 industry study found that 43 percent of companies still manually process their expense reports. Even worse, only 27 percent of these businesses have an in-place method of catching “red flag” expenses.
The report surveyed nearly 600 financial professionals from different company sizes and types. Almost half of the respondents worked as accountants, managers, or controllers.
Surprisingly, the companies that continue to manually generate their expense reports don’t plan to add a targeted expense management program to the mix. In fact, these businesses say that their current systems “work well enough.” This statement seemingly dismisses the high processing costs and looming audit risks associated with manually compiled reports.
Accounting software is the gold standard for tracking business expenses. In certain situations, however, spreadsheet software can adequately serve your needs.
Spreadsheet-based tracking tools
Maybe you’ve just started your business, and have limited expenses. Or, your business is currently an extension of a favorite hobby. In these cases, manually entering a few expenses on a spreadsheet may work. When you begin to incur more expenses, however, it’s better to switch to a full-service accounting software program.
Or, let’s say you’re an Excel expert with a talent for custom spreadsheets. In that case, you’ll probably be able to create an expense tracking template that meets your needs.
- Excel spreadsheets – Microsoft Excel is a popular spreadsheet software program that organizes and stores electronic data. A competent user can easily manipulate the data and execute mathematical functions. Excel also lends itself well to custom spreadsheets.
- Google Sheets – This cloud-based spreadsheet program is appropriate for personal or business use. The business version features collaborative features. Google Sheets also sync with external systems such as Microsoft Office (including Excel).
Small business accounting software
Sometimes, even the most skilled spreadsheet user will find it awkward to use that format to track expenses. When you reach that point, invest in a high-quality accounting software program that will perform that (and other) functions for your business.
Use your accounting software program to generate regular profit-and-loss statements. These handy reports will help you to gauge the financial health of your business. The reports may also provide data needed for your business tax returns.
A good accounting software program can generate accounts payable and accounts receivable reports. The software can also track invoicing functions, giving you a real-time look at outstanding bills that represent income to your business.
When should you opt for accounting software?
If any of the following scenarios apply, switch to a full-featured accounting software program. Purchase costs are generally reasonable, and you’ll gain invaluable peace of mind in the process.
1. Several business bank accounts
Let’s say you have bank accounts at multiple financial institutions. You may find it very difficult (and increase the chances of errors) by attempting to track expenses for your different accounts.
2. Business owner travel expenses
As a proactive business owner, you might need to visit your customers or vendors regularly. If so, collecting endless expense receipts is an inefficient method of tracking expenses.
3. Multiple employees’ travel expenses
Maybe several of your employees need to travel on a regular basis. In this case, it’s not realistic to track their business expenses via a spreadsheet.
4. Current or projected business growth
Perhaps your business is (or soon will be) in a growth phase. If that’s the case, manually entering expenses on a spreadsheet will soon become painfully inadequate.
How to choose the right accounting software package
When shopping for accounting software, consider whether it’s compatible with your existing financial tools. Ideally, you should be able to sync your accounting program with your business bank account. You should also be able to add credit card and debit card accounts along with receipt apps.
A good accounting program will also handle employee expense reimbursements. These after-the-fact expenses are difficult to track on a spreadsheet. However, the accounting program will quickly process them and provide real-time account updates.
The accounting software package should also include a mobile app that helps you to easily track expenses. Following is an overview of three well-known accounting software programs.
Small businesses and their bookkeeping and tax professionals most often choose Intuit’s QuickBooks Online accounting software. This full-service program offers numerous accounting features. Online training resources and user forums can provide ongoing support.
This well-known accounting package caters to service-based businesses with often-complex invoicing needs. The program also provides functionality for proposals, client retainers, time tracking, and client payments. Finally, FreshBooks can handle a company’s basic bookkeeping requirements.
This cloud-based business accounting package enables access from any internet-enabled location. Expensify manages financial transactions and business expenses via real-time data processing. This accounting software works with iOS (iPhone) and Android devices.
If you’d rather not track expenses yourself, you can hire a professional bookkeeper to perform this function. Every month, they’ll spend a few hours importing your receipts and invoices into the proper accounting functions. And, remember that good records are necessary for making business-related tax deductions.
Expense monitoring and analysis
A spreadsheet full of random line-item business costs is an inefficient expense tracking method. To streamline your expense management, separate your purchases into common expense categories.
By sending each purchase record to its proper folder, it will be easier to monitor business expenses and identify areas of concern. Correctly reported expenditures also facilitate accurate financial report generation.
Expense reports and other financial reports provide a useful snapshot of your business’ fiscal health. Your accounting software program allows you to specify a report’s date range and generate the report from your computer or mobile device.
Tracking your expenses is an integral part of running a business. Start with setting up a business account and credit card, keep track of your receipts, and choose an accounting tool that suits your business needs. Once you’re able to track your expenses efficiently, you’ll be able to determine how to optimize them as well.
For example, one of the best ways to optimize your business expenses is to reduce your credit card processing fees. Over time, you’ll become a better money manager, and your business cash flow should gradually improve. Then, your company will be ideally positioned for continued business growth.
Payment Depot offers wholesale credit card processing rates that can potentially save your business $400 in expenses every month. To learn more about our services and benefits, get in touch with us today!