How to track business expenses in 7 simple steps + templates

Key Takeaways:

• Open a business bank account and decide what software you will use for accurate tracking.
• Choose your fiscal year and accounting method for proper tax reporting.
• Create expense policies and standard forms to control business spending and keep everyone accountable to budget priorities.

Step 1: Open a dedicated business bank account

Separating personal and business transactions is an important first step in tracking company expenses. It helps funds don’t get accidentally misallocated and all transactions are business-relevant.

A separate account can enable efficient expense management, helping you see exactly where funds are going and identify ways to cut spending. Plus, you can access and organize your business transactions, savings, and merchant services come tax season.

Business accounts also keep you compliant with relevant legislation and help prevent you from being personally liable for business obligations.

For example, if you take payments, you likely need a merchant services account, which offers purchase and data protection for your customers. With providers like PayPal, you can open a business account that integrates with popular e-commerce platforms to facilitate payments.

Step 2: Choose between accounting software and DIY expense templates

There are three general ways to track your business expenses:

Freelancers and entrepreneurs may benefit more from DIY accounting, especially if you’re a service business with only a few expenses. It involves keeping physical records and receipts to either submit in a tax package or to enter financial data into a digital spreadsheet tool, like Excel.

This method is straightforward but prone to errors and difficult to scale. As you get larger or if you sell products, automated solutions become beneficial.

Accounting software typically offers additional features, such as real-time data reporting, sales integrations, and integrations with online tax filing.

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

Use a business expense template

If you don’t have the budget for accounting software, you can establish a system by using a simple business expense template.

Keeping all your expenses in one place helps you audit spending and makes tax filing easy. Some online tax filing services will let you upload or import expense reports generated by software, which makes the process uncomplicated.

Step 3: Choose an accounting method for tax reporting

When you start a business, you need to choose an accounting year and method. Consistent accounting methods are critical for tracking business expenses for taxes. Generally, businesses choose an accounting method during their first year and stick to it.

It’s also important to choose a type of tax year based on IRS requirements and the tax advantages you’re eligible for. The most common are calendar year and fiscal year, but there are other potential tax filing year types as well.

Tax years and accounting methods are complicated, and you may be required to report in certain ways depending on your business entity. Consult resources from the IRS, such as Publication 538, and an accountant before making these decisions.¹

Cash accounting method

Cash accounting involves reporting income and expenses in the year that you actually pay or receive funds.

Businesses with simple operations or small gross receipts may want to use the cash method. However, there are exclusions and exemptions: A corporation that isn’t an S corporation likely can’t use this method.

Example of cash accounting: You receive an invoice at the end of Tax Year 1 and pay it at the beginning of Tax Year 2. You’ll report the expense in Tax Year 2, when you paid the invoice.

Accrual accounting method

Accrual accounting involves reporting income and expenses in the year that they become valid. For income, this involves a complex “all events test” to determine when you’re entitled to receive it.

Businesses with inventory or those with more complex operations may be required to use this method.

Example of accrual accounting: You receive an invoice at the end of Tax Year 1 and pay it at the beginning of Tax Year 2. You report the expense in Tax Year 1, when you received the invoice.

Step 4: Connect your business bank account to your accounting system

A good way to track business expenses is to automate them by connecting your business bank accounts and credit cards to an 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.

Integrations are a key functionality of most accounting software. For example, PayPal business accounts integrate with third-party accounting software.

A combination of account discipline (only using business accounts for related expenses) and software integrations means that every expense is tracked and ready to report.

Step 5: Compare income and expenses

Understanding the margin between expenses and revenue is important for ongoing operations as well as determining your business’s taxes. One key benefit of accounting platforms is that they can integrate with both sides of your finances at the same time.

No matter what approach you take, these basic rules help simplify expense tracking:

• Review and identify expenses: Document each expense item related to your business, such as company car payments, equipment costs, office leases, and software purchases.
• Categorize expenses: Base categories on your budget allocation and the business function they contribute to. For example, operating expenses may include rent, payroll, and insurance. Cost of goods sold (COGS) may include production and inventory costs. Marketing and advertising may include paid ads, event attendance, and influencer collaborations.
• Keep receipts: 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.
• Digitize physical receipts: You may need to keep your business expense receipts for multiple years. You can use a business expense receipt manager to help you digitize and document your receipts as you incur expenses.
• Treat invoices like receipts: Invoices serve as important records for tracking client payments, subcontractor costs, and other expenses you may incur as a business. You should also keep digital records of your invoices to reference for your tax returns, balance sheets, and profit and loss reports.

Step 6: Implement a spending policy and standardize expense reporting

If you have employees and multiple people making purchases on behalf of your business, you may need to create a policy for how they should pay and report expenses. 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?

Businesses handle employee spending in two main ways:

1. Entrust a limited number of employees with business cards to make transactions with, and then file an expense report after. This is efficient but requires substantial trust.
2. Ask authorized employees to make purchases themselves first, to be reimbursed after they submit an expense report. This is a slow process, but it gives you control over what gets paid for and when.

Develop a standard expense reporting form that all employees should use. This creates a record that goes beyond a receipt, contextualizing the expense and keeping people who spend funds accountable to business owners.

Step 7: Establish a process to review expenses regularly

Unnecessary expenses can hold back growth and become problems during tax season, so it’s important to catch them early. Budget visibility is also key to maintaining sustainable profit margins as businesses grow.

Owners should create a process to audit small business expenses and make it part of regular operations:

• Create expense reports: Create a spreadsheet of current expenses with the date, payment type, description, type of expense, and total amount of each entry. This record can help you spot potential errors and your financial information to be up to date.
• Review reports weekly or monthly: Flag and reconcile any issues in the reports. Once a period ends, approve and archive the expense record, and start a blank document for the next period.
• Keep target budgets based on expected income: Forecasting income and basing an expense budget on it ahead of time can help you keep operating margins where you want them.

Different types of business expenses

Tracking expenses for small businesses can be complex because you might quickly outgrow existing solutions or find that charges vary monthly. You may also have unique expenses based on the industry you’re in.

In general, expenses can fall into a number of categories related to how often you’ll encounter them:

• Fixed expenses: Remain consistent from month to month, like subscriptions
• Variable expenses: Change significantly from month to month, like supplies.
• Unexpected expenses: A type of variable expense that isn’t planned for, like theft or disaster
• Accrued expenses: Expenses that are entered into the books before the business pays them out, like wages and taxes

Additionally, common types of small business expenses include:

Non-deductible expenses for small businesses

Unlike ordinary and necessary business expenses, such as a new laptop or a company cell phone, personal expenses are considered nonessential to operating a business. These are known as non-deductible expenses and 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.²
• 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 buying tickets to concerts or sporting events.³
• Certain customer gifts: Businesses can only deduct customer gifts up to $25.⁴ And, again, gifts that are considered entertainment purchases, like event tickets, are often not deductible at all.

Benefits of tracking business expenses

By tracking business expenses, you can better understand how much you’re spending to keep your operations running. This is one of great ways to analyze whether you’re overspending and how you may be able to cut costs. Expense tracking also helps you comply with tax laws, pay less tax, and prepare for the future of your business.

Understanding tax obligations and tax breaks

Documenting your expenses helps you make deductions come tax season. Relevant business expenses also come with tax benefits; They’re considered “deductible,” which means they come with certain tax advantages.⁶

Businesses can claim:

• Credits, which are subtracted from the tax that you owe
• Deductions, which are subtracted from the amount of income that you pay tax on

According to the Internal Revenue Service (IRS), a business expense must be both ordinary and necessary to be considered deductible.¹ In other words, business expenses must be both common and accepted in your industry as well as helpful and essential in doing business.

Your business structure can impact the types of taxes you owe and what you can claim credits and deductions for.

Sole proprietors, for instance, generally have to pay estimated taxes throughout the year as well as self-employment taxes. Meanwhile, businesses with employees have to pay employment taxes, and businesses that sell certain goods, such as tobacco and alcohol, have to pay excise taxes.⁵

You should also have a record of your spending in case your business is ever audited by the IRS.

Improve business financial planning

Outside of just improving your internal bookkeeping, tracking expenses can also help you make important decisions for the future of your business. Small business owners should understand accounting basics and best practices to prioritize profit and grow.

For example, good accounting 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 create profit and loss statements for official use.

Challenges to expense tracking for small businesses

Small businesses have unique challenges in all their operations. When it comes to expenses, a lack of experience and mature systems can lead to mistakes.

Time and resource limitations

Accounting expertise isn’t easy to come by, and it doesn’t come cheaply. Small businesses may not be able to afford dedicated staff for accounting and operations; that’s often the owner’s role.

When you’re doing everything yourself, it’s easy to overlook things and make mistakes. External expertise and software can help reduce the burden.

Mistakes, errors, and lost records

Without robust tracking systems, it’s easy for things to get lost and forgotten. You might have small expenses, easily forgotten about. Or you might work with service providers who only provide physical receipts, which are easy to lose.

There’s always a risk of input error, especially if you aren’t using automated software.

Manual accounting is a bottleneck

It’s difficult to grow manual systems into processes that work for multiple team members. As small businesses grow, individual manual processes become inefficient. What worked for a solo operator doesn’t scale up to a business with a team.