5 Pitfalls of Accounting Software

When I say accounting software, I'm referring to software designed for small business, not the expense, more complicated accounting systems.

The classic examples are QuickBooks and Xero, but I'm sure there are many more.

To be straight up, we are not CPAs at Webtimeclock, we are developers who happen to build software to accommodate accounting principles.

By default we had to learn double-entry accounting and three-way accounting models to build our backend services. We know how it works and we know why it works.

In this article, I hope to point out some things we have noticed. So if you are a small business owner, these tips might be helpful.

The real problem

The problem isn't necessarily the software, the problem is users not understanding what they are doing. Think in terms of "garbage in, garbage out".

Without guardrails, your company's books can quickly become a complete mess without understanding how to fix it, unless you hire a professional.

Think of it this way, accounting is the language of business that...

• Records your performance
• Reports you your business health
• Prepares you for taxes
• Helps you sell your business
• Helps you to apply for business loans
• Helps you make better business decisions

The real problem then, and this is not a criticism, is that many business owners don't have the faintest idea how to do accurate bookkeeping. Many make the assumption that accounting software will do it for them.

Why use accounting software for small business?

For many small businesses (not all), a top priority is to lower costs by avoiding hiring a bookkeeper, and instead, hiring software to do the job.

No need to pay wages to an in-house bookkeeper, no need to pay an expense such as an outsourced bookkeeper, just connect your bank account, and call it a day.

It's not hard to assume spending between $20 and $120 per month might be a better deal than spending hundreds per month.

• Lower cost
• No need to hire in-house bookkeeping
• No need to outsource bookkeeping
• Simple and easy
• Access anywhere, any time

Pitfall 1: Not understanding double-entry accounting

For centuries, business books have been a combination of journals and ledgers... Accurate books start with accurate entries. Double-entry accounting was created a long time ago and has proven to be the most efficient way to account for business finances. The trouble is many business owners don't understand it.

• It doesn't come naturally, you have to learn it
• It takes practice to fully understand it
• Perceived as difficult, when in reality it is not
• Assumed that software does this for you, so why bother learning it

Although accounting software will allow you to enter cash sales and expenses without understanding double-entry, trouble can happen when dealing with receivables, payables, and equity.

Piffall 2: Not understanding three-way financial statements

Three-way financial statements include Income Statements, Balance Sheets, and Cash Flow Statements. All three reports link together to display your business health.

They connect every dollar a business receives, owes, and requires to operate. Think of them like a highly detailed credit report that constantly evolves every day.

However, like double-entry accounting, many business owners don't have a clue.

• They don't come naturally, you have to learn them
• It takes practice to fully understand them
• Perceived as difficult, when in reality they are not
• Assumed that software does this for you, so why bother learning it
• Assumed your tax accountant can handle it at the end of the year

Although you can run a business without understanding financial statements, don't expect your software to do them correctly.

Pitfall 3: Relying on bank feeds

Although they can free your time, bank feeds in accounting software are a double-edged sword to your books. They can work great until they don't.

To do it right, you still have to monitor them closely and make sure they are categorized correctly. Otherwise they can mess you up big time.

• Feeds do not automatically categorize entries
• Entering category rules, may not work for every circumstance
• All bank, credit card, and merchant accounts may not have available feeds
• Feeds may not show transaction relationships such as invoices, cogs, and sales taxes

A bank feed feature is not necessarily a bad idea, the trouble is relying on them to maintain accurate books. That should never be assumed.

Pitfall 4: Not categorizing transactions correctly

In accounting things like Assets, Expenses, Revenue, Liabilities, and Equity have real meaning.

Sure, accounting software can help you list a canned COA (Chart of Accounts) to go by, but it may not explain what to do with them.

Categorize them right and all is good, get them wrong, and your books get messed up.

• Categorizing is a fundamental task in accounting
• Categorizing correctly keeps your books balanced
• Categorizing incorrectly messes you up
• Categorizing isn't necessarily something software does automatically

Software cannot assume what is a sale, expense, asset, liability, or equity. It's up to you what goes where, so it is good to know how it works.

Pitfall 5: Not updating books regularly

Bookkeeping is a never ending process to your business, it should happen every day with every transaction.

Not keeping your books up to date won't necessarily hurt you, but it can lead to some potential problems down the line.

• Updating regularly helps keep accurate financial statements
• Updating regularly helps to not miss tax deductions and deadlines
• Updating regularly helps control cash flow issues
• Updating regularly helps prevent mistakes that require a professional to correct

Software might update your bank feed regularly, but that won't include all the entries that don't use a bank feed.

Conclusion

Accounting software can certainly help with your bookkeeping, as many companies use them every day.

If you use a professional bookkeeper, great, hopefully they are qualified in the language of accounting, keep your records current, and help manage your business finances.

If you do them yourself, that is also great, but make sure you learn double-entry accounting, understand three-way statements, and update your records regularly.

Either way, it's always a good idea to hire a CPA to check your work.