How to Categorize Your Expenses
At least once a month you should categorize your expenses, but how to categorize your expenses actually? In this article, I’ll outline the steps I go through for each of my clients when I do categorizations each week.
The Quick and Dirty
Here’s the quick overview of transaction categorization:
1. Gather your receipts
2. Go through your bank feed in your bookkeeping software and categorize
3. Record any business expenses that occurred in personal accounts
Gather Your Receipts
First step is to gather your receipts. This can be physically or electronically. Whether you attach a copy directly in your bookkeeping, have an email/desktop folder, or a good ole fashioned shoe box, it doesn’t really matter as long as it works for you and there’s a copy accessible in case of an audit.
Keeping receipts isn’t just for a potential audit; it’s a memory aid so you don’t have to remember what that Target purchase a month ago was. Receipts are your mental sticky note freeing up space in your brain to focus on other business tasks.
Once you have your receipts, go into your software and proceed to the bank feed page. In Xero and QuickBooks you can easily access bank feeds from the dashboard. Once in the bank feed page, verify that the transaction matches the receipt and include:
· who the expense was paid to
· what it was for (description)
· the category it belongs to
Including the description is super important. Just like with the receipt, this is the place to tell your future self what the heck this expense was actually for. Leaving the description blank is sure to waste hours later as you try to remember what you did months ago.
QuickBooks and Xero will try to be “helpful” by suggesting previous entries. You see this in QBO with the green fields, and in Xero with text in the match column. Do not be fooled! These “helpful” suggestions are wrong most of the time and blithely accepting the software suggestion is a sure route to disaster.
As advanced as machine learning is, the software does not know better than you.
How long does this all take? For clients who have about ten transactions per week it takes me about 12 minutes to categorize. You can probably find 12 minutes today.
Record Personal Expenses
Lastly, record any expenses that occurred outside your business bank account. If you used cash to pay for something, create a petty cash “bank” account in your software and manually create those transactions. If you paid for a business expense with personal money, create a bill in your bookkeeping software to pay yourself back for that purchase.
Helpful Category Tips
Here are the two most common mistakes I see with categorization.
Computers and equipment – Standard in the chart of accounts for most bookkeeping software is a category called Computers & Equipment. Great! This is where you should put that new printer or laptop, right? Not quite.
This Computers & Equipment account is for assets, which have special rules and must be treated differently from everyday expenses. Within most businesses, assets are purchases of $2500 or more where the item has a usefulness of more than a year. Sometimes smaller purchases can be considered assets, but that is a conversation between you and your accountant.
If your new laptop was $1000, it’s better suited to an expense category (one you might need to create) like “Office Equipment,” or “Computers (non-asset).”
Transfers – Say you have a business checking and PayPal connected to your bookkeeping software. An expense happens in PayPal and funds transfer from the checking to pay for it. The expense happened in PayPal and should be categorized as such there. The funds going from the checking to PayPal is a transfer and should be marked as such!
Transfers should be used anytime money flows between business accounts. There’s some psychological block I see with many business owners where they don’t want to use the transfer feature in the bookkeeping because what if it actually transfers that money in your bank? It can’t. Go ahead and use the transfer feature when appropriate.
Transfers should not be used when transferring money from a business account to a personal account. In this case, money is moving from within your business to outside your business. This is the appropriate time to use Owner’s Draw (if you’re a Sole Prop or LLC) because you are taking money out of the business.
Now knowing how to categorize your expenses, it’s time to implement. The best way to do this is set up systems and automated reminders so that categorizing becomes a habit.
No one, not even bookkeepers, looks at a year’s worth of transactions and thinks “this’ll be fun!” No, that much of uncategorized transactions is a hassle and the best way to avoid this is carve out small amounts of time regularly.
Take the steps above, put them into your task management system, and create a repeating task so that when you sit down to do your bookkeeping you know exactly how to categorize your expenses.
I’m Morgaine Trine - the Financial Strategist and Bookkeeper at Honestly Bookkeeping, a firm dedicated to helping creative entrepreneurs create long-term wealth and build sustainable businesses.
The goal of any business isn’t to make money. It’s to support the life, dreams, and goals we each have as an individual. That just happens to take money. And since it does, I’m here to help you bring in the cash, manage it well, and make informed decisions with your finances.
When not behind the computer screen, I'm reading a book or traveling somewhere new. Probably both.