It’s almost the tax submission deadline (for businesses) again. This year, I handed my accountant my records a whole 5 weeks before the deadline, so she has plenty of time to compute my taxes.
It wasn’t always like this. Filing my tax return in the first 2 years of running my business was a big headache and involved sleepless, stressful nights leading up to 30 June. I’ve come a long way since and thought I would share my process to help individuals just starting out.
Disclaimer: I am not an accounting professional. What follows is what works for me – your own mileage may vary. You should take this article as a guide, and consult a licensed accountant for specific questions.
First, let’s be clear about what my system is and isn’t. This process works to:
- Record invoices and payments (money in)
- Record expenses (money out)
- Make it easy for you or your accountant to compute and file your taxes
This system isn’t a solution to:
- Be an accounting solution
- Generate financial statements
- Forecast your business financials
It’s important to stress that this isn’t really an accounting system – it’s more of a bookkeeping system. For most freelancers and sole proprietorships though, it is quite adequate.
If you’ve just started your business, I don’t think you need a full-on accounting solution like Quicken or MYOB. It will confuse you and make it an enormous chore to keep your books in order. Just keep it simple for now.
Getting Set Up
Your bookkeeping will not magically fall into place without preparation. Here’s what you need.
Do not mix your business and personal bank accounts. Ever. Even if you haven’t formally registered your business, go open a separate account just for your freelancing business.
Ideally you should open a current account so that you can write cheques. However most banks in Malaysia require that someone introduces (vouches) for you before you can open your current account. Maybank’s basic current account also requires a minimum deposit of RM500. If your business is more than a side job, go open a current account.
If you are just freelancing on the side and feel that you can make do without writing cheques, you should at least open a savings account with online banking. This way you don’t need to run to the ATM to make a bank transfer every time you need to pay someone.
Start using invoicing software
Upon completion of a project or at the end of the month, you send the client an invoice stating the amount owed by them for your products or services. You can generate your invoices manually with a word processor or spreadsheet software, but it’s much better to use dedicated invoicing software because it can generate reports, track who’s late to pay you and more. Remember to look out for specific features like multiple currencies or time tracking if you need them.
Web-based invoicing software
There are many options for web-based invoicing software. Many are free for basic use, but charge you a monthly fee when you need to send more invoices. Freshbooks charges based on the number of active clients you have on file. The Invoice Machine charges based on the number of invoices you send. Invoice Bubble is a great, free invoicing service but they will display a small logo on your invoices. PayPal also provides a full-featured invoicing solution.
Most of these services will allow you to also create estimates, which can be easily converted into invoices after clients have agreed to the estimate. Many web-based invoicing software will also give you the ability to send invoices via email, complete with a Pay Now button that integrates with PayPal and other online payment systems.
Another web-based invoicing option is Pancake App, a self-hosted invoicing and project management web app that you install on your own server. You get all of the benefits of the apps mentioned above, without the monthly fee. You’ll need a little technical ability to set it up (they offer a setup service), but once it’s done the app is almost as good as the desktop invoicing options below.
Desktop invoicing software
Personally I prefer using a desktop invoicing software because there are no monthly fees. The software that I use is Billings for Mac and costs USD40. There are many Windows equivalents. It’s one of the best investments I’ve made for my business because it saves me time, and my time is worth much more than the money I paid for it.
Whatever invoicing solution you use, make sure that you number your invoices in ascending order, and never duplicate invoice numbers.
Set up your spreadsheets
Since we are keeping things simple, we are going to use the good old spreadsheet for our bookkeeping. We’re going to need 2 sheets:
The Cashbook records all of the payments made into and out of your business’s bank account.
The Expenses sheet records all of your business-related expenses. D’oh, right?
Here’s a sample sheet that I made with Google Docs which you can use as your template: Simple Bookkeeping for Freelancers & Sole Proprietors. Alternatively, you can download the Excel version.
Finally, we’re getting into the actual workflow of the bookkeeping system. Here’s how it goes.
Step 1: Record Invoices
Using your invoicing solution, generate invoices for each service or product you provide. Make it a habit to invoice clients every Monday, so that your invoices are never more than a week late.
Step 2: Record money in and out
When you receive a payment for your invoices, note down the cheque number and bank in the cheque. In your Cashbook, record the date, amount (money in), the invoice that is being paid, and cheque number. Refer to the sample spreadsheet from above. Print out your invoices, or summary of invoices to file away.
Your Cashbook will reflect the money in and out of your the bank account for your business. However, because you have added the details above, your accountant can connect the money you received with the cheque that was used to pay it, and the job that it paid for. At the start of a new month, copy the end balance to the new month (refer to the Cashbook in the sample spreadsheet)
There are 2 types of money out for your business – direct expenses and claimed expenses.
1. Direct expenses are paid from your business bank account for expenses related to the running of your business, e.g. paying suppliers and vendors, buying goods which you re-sell back to your customers, etc. Pay for your business expenses with your cheque book and record the date, cheque number, amount and payee into your Cashbook. Print out the invoice or bill that you paid for and file them by month. If you don’t have a cheque book, pay with online banking. Be sure to print out the transaction receipt and file it away.
When paying money out, you can also use a Payment Voucher to show that money has been paid out of the bank account and to show who the money was paid to. I personally don’t issue PVs to suppliers and vendors as some of them are outstation and it’s difficult to get their signatures.
2. Claimed expenses are paid from your own personal accounts (cash, credit cards) for expenses related to the running of your business. For example, I need to pay for my client’s Facebook ad campaigns with my own credit card because my business bank account doesn’t have one. In this case, I record the date, item, receipt/bill number, category and amount into the Expenses sheet. Add your own categories to the ones below.
You should also record expenses for your personal meals and entertainment, petrol, phone and internet bills, vehicle maintenance and electricity bills. Why? As a sole proprietor, you are the business. It wouldn’t exist without you. So a percentage of these personal expenses are claimable as business expenses. Your accountant will work out the exact percentage when computing your accounts.
Here are some of the personal and business expenses that you can claim for. Use these categories in your expense to help your accountant work out how much you can claim:
- Meals and entertainment
- Upkeep of computer
- Office expenses
- Maintenance of motor vehicle
- Tax / accountant fees
For all money out transactions, remember to save and print out the receipts, bills or invoices. You need to prove that you paid for these expenses. I glue all my petrol and meal receipts to sheets of paper so that they’re not loose and so they are easier to file.
Step 3: Pay yourself
Every month you should reimburse yourself for the claimed expenses that you’ve paid from your personal accounts and make a draw. Total up the previous month’s expenses and issue a cheque to yourself for that amount. As a rule I only reimburse my expenses for a whole month.
Referring to the Expenses sheet, if I only process my claimed expenses on 7 Feb, I will only reimburse myself for Jan. The expenses incurred on 3 and 4 Feb will be grouped together with the rest of Feb expenses when I process them in March. This makes it easier for me to keep track of what I need to reimburse myself.
Besides reimbursing expenses you can pay yourself with an owner’s draw. Owner drawings are when the business owner takes money out of the business. It doesn’t have to be a set amount each month, feel free to take as little or as much as you need. However you should leave some money in the bank account so that the business has money to pay suppliers and vendors.
When you pay yourself, you should also use your business’s cheque book and record the money out in the cashbook. Here’s where the Payment Voucher comes in handy – issue one to yourself to show that you received the money from your business.
Filing Your Taxes
If you’ve followed this system, you can simply give your accountant the Cashbook and Expenses sheet along with the other supportig documents when it is time to file your taxes. Using the information you have compiled, the accountant can easily generate your profit and loss statement to calculate your business profits for the tax return.
Why do all this work if you need an accountant to file compute your accounts? Because it’s even harder to track everything, and then generate your financial statements. If you don’t know what are the 4 basic financial statements, hire an accountant. It’s not worth the headache.
Remember that you are legally obligated to file your tax return and pay your taxes. I don’t imagine it would be very fun (or profitable) if you are hauled up for not filing your tax returns and then going through years worth of bank and credit card statements, bills, etc to try to figure it out.
Understand Your Business
Beyond taxes, balancing the books for your business allows you to better understand the financial standing of your business. Many freelancers and microbusinesses have an idea of how much money they are making, but don’t have any idea how much they are spending. I was like this, and I had no idea if I was profitable or if I was wasting all my profits away with my expenses.
Having your books in order also informs you how much it costs to run your business, so that you can plan and budget how much revenue you need to make each month. Ultimately it will give you a sense of control over your business, and with that allow you to run your business better.
I hope this article was useful. I will update and revise it as I go along when I get new information from my accountant and other sources. Please feel free to ask me questions in the comments about the system. However if you have more specific accounting questions I would advise you to consult a certified accountant.
All the best with your bookkeeping!
19 Nov 2011 – Added common expense categories that are claimable / eligible for write off