Many small businesses struggle to stay on top of their business expenses. Indeed, paying operating expenses is the most common financial challenge uncovered by the Federal Reserve Small Business Credit Survey, and 47% of business owners said they would be forced to use their personal funds if revenue disappeared for two months.
Tracking, recording, and analyzing expenses is a basic component of financial management, and when done properly, it can dramatically increase the chance of a business avoiding such financial issues. By tracking expenses, a business can plan better, anticipate slowdowns in cash flow and make sure the most important business expenses—such as payroll—are always met.
As a business owner, you must account for and manage several types of expenses to keep your operations running. Categorizing these expenses can help you effectively plan your finances, maintain an organized record of all transactions, and file taxes with ease. Understanding the key business expense categories can also make it easier to identify what is and isn’t tax-deductible.
In this article, we will discuss what these small business expenses are, how to categorize them, and how expense tracking can benefit your business.
What Are Tax-Deductible Business Expenses?
Tax-deductible business expenses, or “tax write-offs,” are costs that business owners can deduct from their total revenue to determine their taxable income. In essence, tax-deductible business expenses can reduce the amount of taxes you have to pay for operating and profiting from your business.
Here are some key examples of tax-deductible expenses:
- Business use of home and/or car
- Direct labor
- Office or storage facility rent
- Insurance payments
- Utilities like phone bills, internet service, etc.
Small Business Expense Categories
Categorizing business expenses can make it easier to identify deductible items and file tax returns. Here are the main deductible expenses for small businesses to keep in mind.
Business-related tax expenses like state and local sales tax, state and local income tax, personal property tax, and excise tax may be deductible.
Utilities and Rent
Expenses paid for utilities necessary for your business to remain operational can be deductible. These expenses can include your telephone, internet, and electricity bills, and rent paid for your office and additional storage space.
The ordinary and necessary cost of insurance can be deducted as a business expense if it is specifically for your business or trade. Examples of tax-deductible insurance expenses include insurance premiums, general and professional liability insurance, commercial property insurance, and data breach insurance.
If you use a car or a similar vehicle for business purposes, cost of ownership and operations can be tax deductible. More specifically, the cost of gas, mileage from business use, parking fees and tolls, and depreciation (though there are certain criteria for the latter) can be considered deductible expenses.
The wages you pay your employees or contractors for direct labor can count as a deductible business expense.
How To Categorize Small Business Expenses
Categorizing business expenses can be helpful, but it may feel challenging and overwhelming if you have never filed business taxes before. Whether you are a new business owner creating efficient systems for expense tracking, or a seasoned entrepreneur looking to change your financial records system, here are some ways to categorize small business expenses.
Set Up a Separate Expense Account
Setting up a separate bank account for handling specific business expenses can make tracking easier. For example, you can pay all your phone, internet, and electricity bills through a separate “Utilities” account.
Use a dedicated business credit card.
With a dedicated business credit card, the business can establish a credit history to receive financing (and optimal financing terms) when it’s needed. Having credit also gives the company a way to make big purchases when it’s just starting out. Not surprisingly, available credit is an indicator of overall financial health—65% of businesses in poor financial health reported that they had no available credit on their credit cards, but 87% and 95% of businesses with above-average and excellent financial health, respectively, had credit available, per the Federal Reserve study. The SBA says credit cards help businesses negotiate favorable agreements with suppliers and can help protect businesses against identity theft. Credit cards offer perks for the business, as well, such as business rewards or travel rewards.
Choose cash or accrual accounting.
Every small business must pick a set of rules for determining when to report income and expenses. This provides a consistent accounting method for tax purposes. In general, small businesses with $25 million or less in annual gross receipts for the three prior tax years can use either accrual accounting or cash basis accounting (the previous limit was $5 million).
However, because accrual accounting is the recognized accounting method under generally accepted accounting principles (GAAP), most private companies—with some limited exceptions—require this approach for financial reporting.
Cash basis accounting can be a more straightforward approach and easier to manage for small businesses because it records the transaction when the payment is received. Expenses are deducted in the tax year they are paid. Accrual basis accounting records the transaction on the books upon completing the sale and allows for businesses to deduct it in the tax year in which it was incurred, regardless of when the payment is made. Accrual accounting requires double-entry bookkeeping and paints a more accurate and complete financial picture because it takes a long-term view of the business.
Choose accounting software to automate record-keeping and track expenses in one spot.
Fifty-eight percent of U.S. respondents surveyed by Robert Half reported their companies now use either some or only cloud-based solutions in accounting and finance functions. These solutions make it simple to monitor, organize and pay expenses, whether invoices from a supplier, a rent payment or payroll. They can reduce the work required to track expenses and increase the accuracy of this information. Additionally, accounting software has reporting tools that can reveal money spent on each category or provide year-over-year comparisons.
Review and categorize expenses regularly.
The more often a small business reviews its numbers, and the better it understands them, the more likely it is to survive and grow. Business leaders need to grasp the current- and near-term financial health of their organization and looking at expenses and related metrics frequently is a crucial part of that.
Why You Should Track Business Expenses
Tracking business expenses can help you in the following ways:
- Expense tracking helps you identify tax-deductible expenses and gets you better prepared for tax season.
- A well-maintained transaction record can come in handy during business audits and inspections.
- Regularly tracking business expenses can help you determine how you are doing financially, your business’s potential for profitability, and what needs to change.
- Expense tracking helps you categorize and organize all the financial data essential to keep the business running.
- Tracking business expenses also helps you budget effectively and find external funding if required.
Whether you’re just starting out, are in the process of building your business, or are a well-established business, you need to track your business expenses.
So take a few minutes and put a plan in place that will allow you to track your business expenses easily and accurately.