For a small or new business, some challenges go beyond operations. From compliance matters to accounting and record keeping, SMEs must prepare themselves for the changing business and regulatory environment. However, committing errors, whether knowingly or unknowingly, will result in non-compliance, cash shortages, poor decision-making, and so on. Therefore, it is important to highlight the importance of proper record-keeping. In this blog, we refer to the top 5 accounting mistakes SMEs must avoid for smooth operations.
What is Accounting in General Terms?
With respect to financial decision-making and the consumption of financial know-how of a business, accounting is a process that converts raw data into information. It records all the business transactions, processes them, and converts them into meaningful information such as financial statements.
Accurate recording of financial data is critical for a business. This is because it is the backbone of
- Internal decision-making,
- Compliance responsibilities, such as filing tax returns, and
- Communicating with stakeholders, including banks, auditors, and so on.
Therefore, entities, especially the smaller ones, must keep themselves up-to-date with the regulatory changes and adapt accordingly.
Top 5 Accounting Mistakes to Avoid
Depending upon the nature of a business and specific circumstances, there can be numerous instances of accounting mistakes. However, we are providing some of the common ones for SMEs.
1. Ignoring the Separate Entity Concept
One of the fundamental accounting concepts treats a business as a distinct entity separate from its owner(s). This means that personal transactions should not be mixed with business transactions to calculate accurate business performance and position.
This is a problem with small businesses, mostly in the beginning, to separate business from personal dealings. Therefore, entities should separate.
- Business transactions from personal ones.
- Business bank account from a personal account.
- Business records.
Failure to keep distinct records will result in inaccurate accounting records. This, in turn, will result in inaccurate tax filing and inaccurate decision-making.
2. Improper Record-Keeping
Accounting figures and transactions are backed by key documents, for instance, invoices, bills, receipts, and contracts. Failure to maintain proper records will not only affect the overall accounting, but it will also be a violation of the law. For instance, in the UAE, businesses must maintain and keep financial records for a minimum of seven years. Therefore, entities must ensure accurate and safe documentation. Improper records will result in:
- Loss of tax deductions and incentives
- Audit discrepancies
- Problem in tax filing and computation
- Compliance issues
- Penalties
3. Revenue & Capital Expenses Misclassification
It is important to keep the distinction between certain types of expenses for proper recording of data. There can be the following expenses:
- Personal
- Business
- Capital
- Revenue
We have discussed the importance of keeping personal and business expenses separate in part (1). The next two categories need attention here: capital and revenue expenditures.
Revenue Expenses
These are short-term expenses that are mostly recurring to run the business’s daily operations. For instance, salaries, utilities, rent, and so on. These expenses are taken directly to the income statement in the period incurred. Revenue expenses generally do not increase the earning capacity of an entity.
Capital Expenses
These expenses are aimed at buying, upgrading, or maintaining long-term assets that will increase the future earning capacity of a business. For instance, the purchase of property, plant, and equipment refers to capital expenditure. These are actually investments rather than expenses. Therefore, these expenses result in an increase in assets in the balance sheet. As the benefit of these assets is for over a year, these are systematically expensed out to the income statement over the period of time.
The key to remember here is that incorrect expense classification will result in errors in financial statements. Expense misclassification will result in:
- Incorrect assets’ records
- Incorrect profit & loss figure
- Wrong tax computation & filing
4. Weak Internal Controls
Internal controls are a process of policies, procedures, and practices that ensure:
- Operational efficiency
- Financial reliability
- & Compliance.
The primary objective of having internal controls in a business is to safeguard its assets from fraud or errors. As a result, the entity will smoothly achieve its objectives through reasonable assurance of the reliability of financial reporting and operations.
SMEs generally lack internal controls. A business, small or big, must ensure it protects its assets and prevents the occurrences of fraud and errors.
Effective internal controls prevent:
- Frauds & errors
- Unauthorized transactions
- Financial losses
- Non-Compliance
5. Relying on Non-Professionals
Small businesses generally cut costs by employing fewer employees and hiring non-professionals. However, saving money in crucial areas might result in massive cash outflows in the future. Accounting is a professional job; firms need to maintain records as per:
- Accounting standards such as International Financial Reporting Standards (IFRS)
- Local laws and regulations
Furthermore, entities also need to align their books with tax laws. For more information, read Corporate Tax & Accounting Alignment.
Therefore, it is risky to rely on non-professionals. In the beginning, it might seem costly; however, it is beneficial to consult an expert in the long run. In the UAE, there are tax consultancy firms such as CZTA that provide cutting-edge services and accounting packages at reasonable prices.
Conclusion
Some errors are simple; they do not result in adverse consequences. However, for businesses, there are certain areas where committing mistakes can be expensive. In our blog, we mentioned the top 5 accounting mistakes that SMEs must avoid. This, in turn, will protect the entities from any non-compliance risks, wrong decision-making, and financial losses, including penalties, audit discrepancies, and so on. Therefore, companies must work proactively and assess the need to consult an expert. Furthermore, as accounting and taxation are somewhat related, businesses must avoid accounting mistakes to avoid any tax issues.
Creative Zone Tax & Accounting (CZTA)
In the early stages of business, getting expert input will reap benefits throughout the lifecycle of a business. As startup specialists, we provide top-notch services, whether it be accounting or taxation and other legal matters. Contact us today.
