I have a few small business clients who do not bother with traditional accounting. That is, they do not have a system like QuickBooks or something similar to compile, organize and analyze their financial transaction records in real time. In most cases these are sole proprietors. But in one case an owner of a multi-million dollar sales company with more than dozen employees feels that he maintains better financial control keeping handwritten records of day-to-day transactions in his notebook. Today’s online tools provided by banks and credit card companies go a long way toward reducing the amount of manual work that is needed to manage small business accounting. Other business people simply throw receipts into an envelope and deal with the accounting issue at tax filing time.
There may be solid justifications for this avoidance strategy. Many astute self-employed small business people are able to maintain a cognitive grasp of an extensive amount of their own financial information. That is often an effective and efficient way to manage your personal finances. Yet at some point the amount of information in a growing business makes it impossible for anyone to track without automated technology. Aso, some areas of accounting like payroll taxes, are overwhelming without the use of some type of technology-based accounting system.
The obvious advantage of avoiding traditional accounting is the immediate savings of time and money in accounting. For my small business clients in this example, full accounting services would otherwise cost $150 to about $800 per month. They save this expense.
Recently, however, I’ve had a few of these clients audited by IRS or another tax authority. They can’t just hand over their shoebox full of bank statements or receipts. The auditor demands that the information be organized, notated and totaled by category. I had to break the bad news that not only would they incur the expense of answering the auditor, but that now it was necessary to do the accounting that was skipped earlier. In one case an auditor’s strict time schedule meant that we were working almost around the clock for a week. The cost wound up approaching $10,000 audit preparation in order to save $40,000 the IRS would have otherwise assessed.
One of the guys being audited said “they can’t ask for records that I don’t have”. Yes they can. And they can prescribe the format that your records must be supplied. You don’t have to provide those records but then you will then be subject to the full amount of the assessed tax in the audit notice.
It is clear that the cost of doing accounting “after the fact” in response to an audit or examination far exceeds the cost of doing the accounting in the usual way. I would guess, based on my experience, that the cost of preparing an audit response without prior accounting records is two to four times the cost as if accounting records were available.
So my warning is this: if you are not keeping current records in a system like QuickBooks and you are audited, expect the time required to respond to cost significantly more than the cost of accounting services. From a cost management perspective, perhaps we should look at this strategy as audit roulette. You’ll save money now if you slip past the auditors gaze, but the cost will be a killer if you are audited.
My conclusion, for a bunch of good reasons, is that it is better to bite the bullet and keep your financial records in the same system as other small businesses to avoid this risk. The side benefits of better management information will offset the immediate accounting expense.