Not all incoming money is income

When your business gets money in, it’s easy to go into autopilot. Most of the times that happens, it’s probably income. But that’s not always the case. You need to think about everything you enter in.

Services and Products

When you get a check in, ask yourself if it’s for a service you’ve rendered or product you’ve sold. If so, it’s pretty straight forward. It will probably go against an invoice you created because you wanted someone to pay you. So you simply have to receive the payment.

But what about other situations? Not everything matches up perfectly with an invoice. Each transaction has to be considered individually and entered correctly.

Overpayment

At some point in their business, nearly everyone gets a check back because they overpaid a vendor. Of course, you want to avoid overpayment when you can, but that’s not always possible.

Let’s say your insurance rates change and you get some money back. What are you going to do with it?

Well, why did you get it? You didn’t get it because you provided a service or product. You got it because it was an overpayment. Was the amount paid appropriate at the time? Yes, you paid the amount due. So it’s not income, because you didn’t do anything to earn it.

So what do you do with it?

It’s just a deposit. You enter it against the expense line you incurred to begin with. In this example, the refund would be a credit to your insurance expense.

You might think, “Insurance is an expense, so I can’t credit it there.” Yes, you actually can. In that specific example, you know it was really a reduction of an expense, so you credit it to that expense.

Owner Contribution

Another example is owner contributions. I’ve often seen this with companies that are just starting out. They take an owner contribution and call it income. That’s the worst thing you can do!

If it sits in income, you have to pay income tax on it! In reality, it wasn’t income. It was a contribution by the owner to keep the lights on or make payroll. You didn’t do anything to earn it, so you need to categorize it as an owner contribution.

They key is to think about each and every transaction. Often it will match up perfectly with an invoice. But not always. So don’t let yourself slip into autopilot and make a costly mistake.

Leave a Reply

Your email address will not be published. Required fields are marked *