Financial Recordkeeping for Your Online Business
Bottom line: Every online business must track finances (income, expenses, and taxes.) and inventory. For novice businesspeople, the idea of keeping these records may seem challenging, but don’t fear. Popular software programs — particularly QuickBooks — make it possible for you to manage inventory, income, expenses, and taxes with a relatively small learning curve (usually one or two days) and usually for less than $300 a year. In fact, if you want to skip this chapter entirely, buy QuickBooks and find a one-day course in your area that explains how to use the program, if necessary.
What Financial Records You Should Manage
To run an efficient, profitable online business, you will need to manage some or all of the following information:
Income. Income is the money you get from online sales. You will need to transfer the sales information in your online and PayPal accounts into your business recordkeeping.
How to record income. Some online businesses manually enter the information in their accounting software or books. Other online businesses and online stores automatically download this information into their accounting software or spreadsheet program using electronic management tools.
How income affects taxes. It's important to accurately track online sales income. If you get audited by the IRS, unreported income is often the first thing the auditors look for. They will be very suspicious if you have significant bank deposits beyond the income you claimed on your return, even if those deposits are to your personal account. (If you have significant nontaxable income, make sure to keep the records you’ll need to prove where it came from.)
Expenses. Expenses are what you spend on your online business — for example for inventory, wages, rent, telephone, insurance, office equipment, and travel.
How to record expenses. If you are charging your expenses to a credit card or paying them with a bank account with online access, you can download this information to a financial software program or spreadsheet. Expenses that are part of your online account, such as fees, shipping through PayPal, inventory purchases made on online, or subscription fees, can also be downloaded to your accounting software (as discussed below). Otherwise you will have to enter your expenses manually.
How expenses affect taxes. Keeping track of expenses lets you identify every tax deduction you’re entitled to take and is crucial to determining profits. But don’t expect the IRS to allow your tax deductions if you don’t keep records to back them up. If you have no records at all, your deductions will be disallowed in an audit, and you might face penalties as well. If you can prove that you had some business-related expenses of a type that makes sense for your line of work, the IRS may still allow a deduction, but it will be much smaller than what you claimed. Under the Cohan rule (named for a tax suit against entertainer George Cohan), if you can show some proof that you incurred deductible expenses, the IRS can estimate those expenses and allow a deduction for that amount. But, as you might expect, the IRS’s estimates will be low. And this rule doesn’t apply to expenses for travel, vehicles, gifts, and meals and entertainment. The IRS requires more detailed records for these types of deductions.
Sales and inventory. As you buy inventory, you must deduct the expense. And every time you sell an item, you must deduct the item from your inventory — otherwise you won't know what you have available to sell. (Note, inventory Is treated differently than other expenses for tax purposes.) Also keep in mind, even though it's not a tax issue, that sloppy tracking and reporting wastes time and costs money. Efficient recordkeeping enables you to better forecast the future.
How to record sales and inventory. You will need either a spreadsheet or software that can manage both inventory and sales.
How sales and inventory affect taxes. Obviously, sales reflect income, and accurate income reporting is essential for taxes. As a retail business you will also need to generate an accurate inventory report, detailing inventory value at the beginning and ending of the year. Programs such as TurboTax can incorporate your inventory information to determine your tax bill.
Sales Tax. You may have a responsibility for assessing and paying sales taxes. If sales tax is an issue for you, make sure that the accounting or financial management tool you use can calculate the correct sales tax (it can vary from county to county) and provide sales tax reports. Again, programs such as QuickBooks can provide reports of taxable and non-taxable sales.
Payroll. If you have one or two employees, you may be able to calculate, track, and record payroll taxes (and the resulting deductions). If you don't want the hassle, consider an online payroll service such as Paychex or QuickBooks Payroll Services.
Money Owed to Your Business. Known as "accounts receivable," this is money that others owe to your online business. For most online businesses, accounts receivable are the money that customers owe you for completed transactions. You track this in your accounting program — for example, you enter when the sale is completed, then enter when the payment is received and becomes income.
Money You Owe to Others. Known as "accounts payable,"this is money that you owe — for example, subscription fees, loans, or uncompleted payments for inventory. Once paid, these amounts become part of your business expenses.
Income Taxes. Accurate accounting of inventory, income and expenses is essential for preparing your taxes.