In my last post, we covered money in: various ways money may come in to your business that could be something OTHER than income. In this post, we’ll cover money out.
The vast majority of money that will be flowing OUT of your business will be in the form of expenses: paying bills, paying your employees or purchasing your raw materials to make your product.
There are a couple of other ways money comes out of your business that may NOT be an expense. Our first example would be in the event of a customer refund.
Let’s say your business sells widgets for $25.00 each. Mr. Smith buys a widget, gets it home and discovers he doesn’t actually need it, so he brings it back in for a refund. Instead of classifying the refund as an expense, it will ACTUALLy be categorized against the SAME INCOME account that the sale originally went to. This in effect takes the original income out of your sales. If you incorrectly classify a refund as an expense, you’re going to end up paying taxes on the non-existent income. Why? Because that revenue is still going to show up in your sales account! The only way to NOT pay taxes on that revenue is to completely remove it from the sales account.
We know if you have employees to pay, this will come out of the expense funnel. But what about if you need to pay yourself?
If you cut yourself a paycheck right along side your employees, then YOUR paycheck will also be an expense. However, if you are a sole proprietor, partner, or take any draws from your company in general, your paycheck will actually be a DRAW from Owner’s Equity (commonly called an owner draw or shareholder distribution). A draw is not subject to standard payroll taxes (social security, medical and federal withholding) and will only show up on your balance sheet, not your profit and loss statement. ***A word of caution – there will still be federal taxes owed. Contact your tax preparer or CPA to discuss the implications of taking distributions from your company and to obtain a recommendation about how much to set aside to pay for your self-employment taxes.***
Properly classifying transactions is SO important and can have very far-reaching effects if not done correctly. If you are ever unsure where a transaction goes, do not hesitate to contact your accounting professional for assistance. Investing in a good accountant’s services NOW is much less expensive than paying additional taxes and penalties to your federal and state governments later. We are always ready and willing to help answer these questions. Feel free to reach out!