How to track expenses for small businesses

As a business owner, there are costs associated with running an operation. Whether you’re a real estate agent who pays annual membership dues or a marketing consultant who requires subscriptions to the latest software, most entrepreneurs incur various expenses related to their business. But here’s the good news: Certain business expenses are tax deductible.

Why tracking business expenses is important

By tracking business expenses, you can gain a better understanding of how much money you’re spending to keep your operations running. This is one of the best ways to analyze whether you’re overspending and how you may be able to cut costs. Expense tracking will also give you a more accurate snapshot of your profit and cash flow over time.

Outside of just improving your internal bookkeeping, tracking expenses can also help you make important decisions for the future of your business. For example, it can help you decide when and why you might apply for loans, lines of credit, or credit cards to cover necessary costs. Expense tracking can also inform how you prepare profit and loss statements for official use. It’s crucial to document your expenses so you can make deductions come tax season, and have a record of your spending in case your business is ever audited by the IRS.

To that end, there are some accounting basics and best practices business owners can use to track their expenses and improve financial planning.

• Create a balance sheet — A balance sheet provides an overall view of your business’ assets, liabilities, and equity. It’s a helpful tool for getting a snapshot of your business’s financial health each month, quarter, or year.

• Know your tax obligations — Your business structure can impact the types of taxes you owe. Sole proprietors, for instance, generally have to pay estimated taxes throughout the year as well as self-employment taxes. Meanwhile business with employees have to pay employment taxes and businesses that sell certain goods, such as tobacco and alcohol, have to pay excise taxes.²

• Choose an accounting method — Cash basis accounting involves reporting income and expenses once a payment has been completed, i.e. once the money has entered or left your account. Meanwhile accrual basis accounting involves reporting income and expenses once you initiate a sale or transaction, regardless of whether a payment has been completed.

How to track business expenses

It’s crucial to know how to keep track of expenses for small businesses. The good news is this process isn’t as complicated as it may sound. To start, consider this rough step-by-step guide on how to track business expenses:

• Review and identify expenses — Document each expense item related to your business, from company car payments and equipment costs to office leases and software purchases.

• Categorize expenses — Add general descriptors for your expenses, such as inventory, travel, and advertising costs.

• Create an expense report — Create a spreadsheet of expenses with the date, payment type, description, type of expense, and total amount of each entry.

• Review data — Complete this process on a monthly or quarterly basis, reviewing and refreshing your expense data as your business grows.

Read on for an more in-depth look at how to track expenses by adopting important practices such as using corporate credit cards and accounting software to improve efficiency.

Open a dedicated business bank account

Separate your personal expenses from your business expenses by opening a dedicated business bank account. With a separate account, you can easily access and organize your business transactions, savings, and merchant services come tax season. You can also use this account to keep track of your business expenses throughout the year, stay on top of business payments, and even identify ways to cut spending.

Use corporate credit cards for business spending

Just as you can create a separate business checking or savings account, you can open a credit card purely dedicated to making business purchases. In addition to helping you track expenses, you can use your business credit card to earn rewards, such as travel and cash back rewards, and build your business credit history. A strong credit history of on-time payments can help prove your creditworthiness to future lenders and investors.

Leverage accounting software

Take the manual work out of expense management by using an accounting platform. Many have tools that can help you organize your expenses and automatically generate financial reports for easier bookkeeping and tax filing.

Connect your financial institutions to your tracking system

Save time by linking your bank accounts and credit cards to your accounting platform. This can help improve accuracy and reduce errors that may creep in if you enter expenses manually. If your software is synced with your accounts, it can also automatically update your information with your most recent business transactions.

Develop a system for managing receipts

Remember to keep digital copies of your business expense receipts and bank statements. When you file your taxes, you can use these receipts to report your expenses and find relevant deductions. Businesses should also maintain receipts in case they are ever audited by the IRS; receipts provide proof that you made certain purchases related to your business. You can use a business expense receipt manager, for example, to help you digitize and document your receipts as you incur expenses.

Record expenses consistently

Along with holding on to your receipts, it’s important to create a weekly or monthly record of your expenses, such as in a spreadsheet or within your accounting software. Regularly reviewing and refreshing this record can help you spot potential errors and ensure your financial information is up to date.

Implement a policy for expenses

If you have employees — and multiple people making purchases on behalf of your business — you can create a policy for how expenses should be paid and reported. This policy can answer questions such as:

• What can be charged to the business and what can’t?

• Are there spending limits for business expenses?

• Which payment methods should employees use for business expenses?

• When do employees need to turn in their expense reports?

• When will employees be reimbursed for business expenses?

Use invoices to track income and expenses

Invoices serve as essential records for tracking client payments, subcontractor costs, and other expenses you may incur as a business. Just as you should keep records of your expense receipts, you should also keep digital records of your invoices to reference for your tax returns, balance sheets, and profit and loss reports.

What are examples of business expenses?

Depending on the industry you’re in, there are many unique expenses that may apply to your company. Categorizing these costs can help simplify expense tracking and taxes for small businesses. Some common categories for small business expenses include:

• Production costs — Expenses associated with acquiring, manufacturing, and delivering products or goods sold. A small baking business, for example, might consider expenses like baking supplies, equipment, and labor.

• Operating costs — Expenses related to keeping your business running, such as home office equipment, security systems, software payments, and mortgage and property taxes for retail locations. For a small food truck business, operating expenses might include vehicle payments, maintenance and repairs, insurance costs, and business license fees.

• Selling costs — Expenses related to marketing and selling your products or services. A small jewelry business, for instance, might expense the costs of social media ads, influencer partnerships, Amazon marketplace memberships, and freight shipping.

Personal vs. non-deductible expenses for small businesses

Unlike ordinary and necessary business expenses, such as a new laptop or a company cell phone, personal or non-deductible expenses are considered nonessential to operating a business and therefore cannot be subtracted from company income on a tax return.

When learning how to track expenses for a small business, it’s critical to parse out these non-essential costs. Examples of non-deductible expenses include:

• Personal meals — Many business meals, such as lunches for employees or food purchases on business trips, are deductible. However, personal meals solely for yourself and without any connection to your business activities are considered non-deductible.³

• Client entertainment — While you often can deduct the costs of attending business conventions or hosting team-building events, the IRS no longer allows businesses to deduct the costs of entertaining clients, such as by buying tickets to concerts or sporting events.⁴

• Certain customer gifts — Businesses can only deduct customer gifts up to $25.⁵ And, again, gifts that are considered entertainment purchases, like event tickets, are often not deductible at all.

Check out more popular tax questions and answers.

Different types of business expenses

There are two types of expenses all business owners should be familiar with: fixed and variable expenses. When tracking your spending, you can divide your expenses into these categories to better understand how they impact business finances.

Fixed expenses

A fixed cost does not change and can be recurring. Fixed business expenses might include office rent, an auto lease for a company car, or business insurance. Fixed expenses can be easy to track and forecast because they remain consistent over time. A small wedding photography business, for instance, might have fixed expenses like camera equipment loans and photoshop software fees.

Variable expenses

Variable expenses change over time, such as month to month, because they are often directly tied to a business’ costs of goods sold or operating needs. Common variable expenses include delivery fees, utility bills, and billable labor.

For instance, if a tutoring company signs up five new students and requires a new freelance teacher to provide services, the company’s variable expenses will increase. Other examples include payroll for a business largely made up of contractors (like the tutoring company), as well as overtime expenditures, raw material costs, and production supplies.

Unexpected expenses are also a certain type of variable expense. These are costs incurred that a business is not expecting, such as sudden equipment failure (e.g., a broken laptop) or expenses related to an emergency, such as theft, equipment malfunctions, or a natural disaster.

Read more on how to manage your operations.

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