Why Categorizing Your Business Expenses Matters Beyond Taxes

Welcome to the Creative Mind Smart Money Podcast where we turn financial confusion into creative confidence. I'm Samantha Eck, the keeper and fractional CFO for creative entrepreneurs. Each week I'm sharing my financial expertise and actionable strategies to help you build a thriving creative business. Plus, you'll hear from industry experts who bring fresh perspectives on growing your business beyond the numbers. Because building a successful creative business starts with strong financial foundations. Your next chapter starts now. You're listening to the Creative Mind's Smart Money Podcast and our topic today is all about why categorizing matters beyond taxes. So we always talk about categorizing transactions and getting them categorized and how important that is for the IRS. But did you know that categorization has a deeper importance than just what we would send to the IRS or just what we need to report on our taxes at the end of the year? Obviously, you might be thinking, "Okay, I only need my books clean up for tax season," which is 100% true. You do need your books clean for tax season. Taxes do matter. But categorization and the way that you categorize your transactions is the foundation of every smart money decision in your business. And there is a way to have all these custom categories and still be compliant in terms of taxes. So it's very important that we kind of talk about this. So why do we even categorize our transactions at all? Why is there even a thing called categorization? Why doesn't matter? Well, first of all, taxes are just one piece. It tells the IRS where our money went. So at the end of the year, if you're a sole prop or a single member LLC and you put that on your schedule C, it does tell the IRS, "Okay, like here is where you spent your money." So yes, that does matter. Proposation also tells you where your money went. It's how you help to build your financial story and really how it gets written. Because without us categorizing things in specific places, you wouldn't have that full grasp and full understanding of what's going on in your business. Let's look at the deeper reasons behind why categorizing is so important. Number one is profitability. So when our expenses are dumped into the broad buckets of a business, you lose sight of what is actually eating your profit. A software bloat, team costs that are creeping up, whether you are spending on office supplies or shipping or whatever it is by having categories for all of those things. So instead of just putting software and do's and subscriptions, maybe having a software and then a do's and subscriptions that is not software. So maybe you have a magazine subscription that you have every month. Having those is very important because it's going to give you ideas of where your money is going. So if you notice that your software goes from $30 to $400 to $400 the next month, you might be like, "Well, crap. I'm spending so much more on software." And again, that is why the categorization matters and why we look on that deeper, deeper level. Okay. So it also helps for decision making. Clean categories can help us to answer, can I afford to hire? Which service is most profitable and where should I cut back? A lot of clients that I work with and we're really focused on profitability, we will even parse out these services in their income. One of the clients I worked with, what we did was she had digital products and she also had group programs. So we pieced out every group program into its own category as well as each digital product. This helped her to understand how much she was making on each of them to see which was most profitable and then make that decision if she wanted to cut things out that weren't maybe having a profit. It also helps her to see, "Okay, you know, I'm making this much in revenue. I can't afford to hire." That gives that full circle perspective. That's what we're saying. That profitability clarity, when we have all these categories and we know what's going where it can really help. Some of my clients, we even categorize software based on the items. So maybe they use Go High Level for their highest clients, their social media clients or whatever, and they use a different software for some of their lower tier clients. We categorize that by client. So we'll have a master category where it's like this package, expenses, this package, expenses. Let's tell them how much of their expenses are going into each package that even narrows it down even more on profitability. So it's really up to what you want to do in order to make your profitability clear and your decision making easier. We also have cash full planning. Breaking out expenses properly like subscriptions versus one time costs will help forecast that what's coming do every month. Realistically, you have those recurring costs. You'll know what's coming and you can plan ahead. Whereas if you're putting one time cost in with subscriptions, like you could just put those all in office expenses. But if you're lumping them all together, you're not truly going to know what it is. I've worked with franchises before that have set chart of accounts. And that sucks because we have to put things in a bucket and there's no customization. Like there is no wiggle room. We can't really customize. Another reason is pricing strategy. Once you have everything kind of like categorized and customized to where you want, it helps you to know your true cost of goods or service delivery, which means that you can price with confidence instead of guessing. If you know exactly what goes into social media management for Instagram and you know that you are going to need this software or this software. And let's say you need a certain project management system. Maybe it works really well with Instagram. Then you know that this is how much it costs you. You need to add those costs into your pricing, right? One thing for like Pinterest services, if you are a Pinterest manager and you have to buy tailwind until when it only works with Pinterest, you know that that's a cost that you need to add into that package. And it's going to give you that clarity, that pricing strategy. Also benchmarking like we talked about before, those categories are going to let you compare your business industry standards. So if your marketing is double the norm, you can dig into why, like you understand why, you know, some of my clients, we don't just do advertising and marketing because that is too broad. Maybe we have sponsorships. Maybe we have networking. Maybe we have social media ads. Maybe we also have print media ads, whatever that is because there's different avenues of advertising and marketing, right? And you can see which ones are bringing you money and which ones aren't where you're spending the most and where you're not. So it's very important to look into all of these categories and really understand them because you can build these all up and then it still makes sense to the tax person at the end of the year. You just want to make sure that you're not overdoing it if that makes sense. Okay, so let's talk about some examples of categorization in action. I had a client at one point who is just dumping a lot of stuff into a miscellaneous expense category, which made them think that their profit was higher than it really was because, you know, they just have everything going into profit. They weren't really looking at what everything was. So if they weren't sure what it was, they just put it miscellaneous, whether it was a deposit or an expense, which really threw off the entire picture of the business because what is a miscellaneous? We have no idea. Like you should know what those costs are. And when we spoke about it and we really dug into it, they said that they just didn't know where to put them. So they just thought, okay, well, I'll just put them on miscellaneous because what doesn't matter. One, that's not good for your taxes. Two, that's not good because you have no clarity on anything that's going on. There was another one where they were separating contractors from payroll, which is a good thing. That's something you always want to do. You don't want to have contractors and payroll in the same bucket. You need to have them separated because when you have those two separated, it shows you the true cost of scaling a team versus people that you have just kind of working on projects and things like that. There has been tons of times where when we're looking at categorization and maybe we have all those services sparsed out, we can see, okay, you know, this product isn't making as much as this product. Maybe we don't need to sell it anymore. Maybe we just need to cut it. And there's been tons of times where we're with clients where that has happened. So beyond the numbers, what are we really thinking about when it comes to categorization in general? Categorization is going to create accountability. When you see where your money is going and like how it's all being formed, you're going to make more intentional spending choices, right? Even without a budget, you're just going to be more intentional with your spending because you see where everything is going. Obviously, again, yes, bookkeeping is in the past. I'm saying, hey, like, you know, we need to watch our spending and I'm sending you a report on the fifth of the month. You're going to know, right? It's also about peace of mind knowing that your reports aren't just ready for the IRS, but they're also being useful to you. You actually have reports that you can utilize for your business, okay? So I want to remind you that you don't just categorize your transactions for your CPA. You also categorize for you and your business and what works best for your business. The categories that you choose and how you choose to set that up is going to shape the story that you can read about your business. So the clearer that you have a good story, the smarter that your decisions are going to be. I know this episode was short and sweet, but it is very important and very vital that we talked about this because it is something that is often overlooked, okay? If you love this episode, please like it, comment, leave a review, share it all over social media, share it with a friend, whoever it is, to make sure that we get some more eyes on this. As always, you know, I appreciate every one of you listening. I appreciate you spending your time with me. You ever need anything? Shoot me an email. Shoot me a message on Instagram. I'm here for you even just to chat. as always I wish you the best week ever and we'll see you next week farewell fellow travelers.