21 Jun Accounting Enigmas: Undeposited Funds Account
For many QuickBooks do-it-yourselfers, it’s possible to “get by” and decode the mysterious language of accounting-ese in the tool. You can look at the graphics within QuickBooks and make logical conclusions about how cash flows through your small business and how it should be reported.
As a QuickBooks ProAdvisor, I agree that the main dashboard can provide a clear sense of your organization and workflow. Using Pareto’s Principle, we know that 80% of the time, standard workflows are the order of the day. But when it comes to accounting, 20% of transactions are enigmatic. Those transactions could result in your sanity going right out the window—along with your ability to file an accurate tax return.
For the non-accounting-minded individual, double-entry accounting contains many mysteries. Today, let’s uncover one of the most persistent problems: the undeposited funds account.
What are undeposited funds?
The undeposited funds account is like a cash box, or storage bin, for your business. Many companies have a credit card processor that dumps all the day’s deposits, less processing fees, into your bank account as one lump sum. If your business falls into that category, you’ll need to use the undeposited funds asset account to unravel it all.
Let’s say two clients of your business both spent equal amounts and were sent an invoice individually for their purchases. You need to be able to apply client A’s payment to his invoice, and client B’s payment to his invoice. If you apply client B’s payment to client A’s account, client B is going to have a fit. He already paid his bill and does not want to receive a past-due notice! The purpose of the undeposited funds account is to help you record which client paid against which invoice, especially when money is being deposited in bulk.
Watch out for processing fees.
When that bulk deposit drops into your QBO bank feed, it is your responsibility to match the portion of the money to the right client’s outstanding payment due. To confuse matters more, some payment methods, like ACH or credit card, may have already subtracted a fee from the gross sum collected on behalf of the processor. You need to make sure that the client gets credited for the whole gross payment before any fees are subtracted. If you don’t, your QBO file will show that the client still owes a 3%-4% fee against their total. Not giving your client a clear picture of how much money they have paid and how much they owe is a surefire way to tick people off and get clients to leave you pretty quickly.
Small errors can have big consequences.
We once worked with a law office that was doing about $5 million in annual revenue, with a client set up on a retainer fee of $850,000. That $850,000 retainer was marked in the books both against the retainer and against undeposited funds. The result was that the undeposited funds made its way onto the balance sheet as a part of their cash assets. Tax time came along, and because of a bookkeeping error, the total revenue of the business was inflated by $850,000! The cash on hand was also inflated by $850,000. Therefore, this simple error required the business to pay taxes on $850,000 of additional income that had never been received. Ouch! No wonder they thought they were being taxed unreasonably.
Can I set up deposits to go directly into the bank account in QuickBooks Online?
Why not set up QBO to make deposits directly into the bank account as a default? This sounds like a good idea in theory, and it even works when you are a small solopreneur. But what happens when you grow? You’ll find that there are not enough hours in the day, or days in the week, to get all your work done.
When business is thriving, bookkeeping has a way of sneaking up on you. It’s often the least desirable task on your to-do list. That’s why it tends to get put off for another day—perhaps when you “have more time” or “can focus better.” When your guard is down because you are out doing other more important things for the business—that’s when the cash flow monster rears its ugly head.
I’ve found nothing good happens as a result of a solopreneur putting off invoicing or collections. About 80% of small businesses in the U.S. fail after one year, with many citing money problems. Poor cash flow management often leaves business owners living check to check, so delaying receivables can mean shooting yourself in the foot. Cash is the lifeblood of business. Even though it may not be intuitive to deposit to the undeposited funds account instead of directly in the bank account, you will thank yourself later. When business gets hectic, you’ll be able to scale to a larger platform—or maybe even hire a bookkeeper!
Reconcile your balance sheet accounts every month.
We make it a point to reconcile the balance sheet accounts every month when we are doing month-end closings. This is important—not only to make sure no income is missing and everything is reported only once. It also matters because it helps you ensure that your receivables and payables accurately match what has occurred in the business.
Reconciliation is also the redundancy that is needed to ensure that no fraud is occurring in your business. Since there is not a bank account that supports undeposited funds or accounts receivables, you need to reconcile these accounts to income received, instead of a bank statement. You must ensure that every valuable penny earned from your hard work has been collected, and nothing more. In the end, it is the reconciliation process that really brings clarity of revenue received to your business.
Reconciling undeposited funds to payments and accounts receivables will result in the eternal mystery of the undeposited funds account being unraveled, and the riddle being solved.