Good record keeping is a vital activity to ensure the success of your business, for several reasons:
- Measuring the success of your business
- Producing correct financial statements
- Supporting limited liability protection
- Filing tax returns
- Handling audits
Measuring Your Progress
You can see if your business is growing and whether a particular strategy is effective by updating your records every month. With this information in hand, you can tweak your business plan all during the year to fix unsuccessful strategies. Delaying until the end of the year to update your records can waste a lot of money.
Correct Financial Statements
Proper bookkeeping during the year permits you to create timely financial statements, which are necessary when you apply for a line of credit or loan. Lenders require accurate information when loaning money to small businesses. Applying for a loan with inaccurate financial statements creates problems and delays. IOU Financial can advise you on what you need in order to secure a loan from us.
Precise record keeping can preserve your limited liability protection during a lawsuit. If your business is sued, you’ll have to review your internal records to gather the necessary information. Another advantage of up-to-date bookkeeping is that it provides protection if a court tries to “pierce the corporate veil” — a phrase meaning that the courts want to see if there is separation between you and your business entity, and that there is no commingling of monies. If this were true, your liability could outstrip the amount you invested in the company. Each state makes its own rules, so it’s a great idea to talk with your lawyer for additional information regarding piercing the veil.
Preparing tax returns takes significant time, but erroneous records can morph it into an expensive ordeal for the business owner and the business’ tax professional. If you pull together your tax returns by yourself and use imprecise records, the return may become a work of fiction. If you use a tax professional but don’t have accurate and timely records, the preparer, who relies on the information you supply, may provide wrong information to the government. Under the law, this is your obligation and an audit can lead to additional taxes, penalties and interest payments.
Proper records are indispensable when trying to favorably resolve an audit. You may face an audit at any time by your state’s department of revenue or from the IRS. Once they reach you, you normally have 30 days to answer, which is rarely enough time for a tax professional to locate the backup for a client’s records if they aren’t being accurately kept. It takes oodles of time to hunt through piles of papers in desk drawers or trying to find information kept in boxes stored within your garage. Those 30 days will go by very rapidly and you risk missing the deadline, causing added problems. Moreover, requesting a last minute extension from the IRS will probably go down in flames.
According to Internal Revenue Regulation 142A, taxpayers carry the responsibility for proving that they are entitled to the deductions that they claim, and this includes the substantiating their claims. In Joyce Lindsay v. the Commissioner of Internal Revenue, the defendant was a tax preparer who worked from her home for many years and was selected for an audit. During that audit, she could not provide the documentation for things such as charitable deductions, contract labor, office expenses and depreciation. The tax court ultimately ruled against more than $37K in deductions because she had inaccurate bookkeeping. Don’t let this happen to you!