7 Types of Spending Activities in Your Retail Store

(and how each should be tracked for tax purposes)

Keeping track of all your spending activities in your retail shop is one of the key components of bookkeeping. In order to do so correctly, it’s important that you understanding that there are different types of spending activities, and that they are not all treated the same.

In this post, we’re going to look at the 7 different types of spending activities that you may encounter, and how to accurately track them for tax purposes.

Types of Spending Activities that Affect Your Income Statement

One of the most common mistakes I see business owners make while doing their own bookkeeping, is assuming and tracking all spending activities as expenses that show up on their income statement. But in fact, only 2 of the 7 types of spending activities CONSISTENTLY hit the income statement. The rest primarily hit the balance sheet.

So, what are these types of spending activities that actually affect the income statement? Let’s take a look!

Operating Expenses

Although this is just one category of spending, this one will make up a pretty good portion of all your spending. This includes the payments you make for rent, utilities, software, advertising, supplies, etc… They’re the things you pay for to make sure you can keep your lights on and your store operating smoothly. Generally speaking, operating expenses are deductible in the year that you pay them, and they can be used to lower your taxable income.

Payroll Expenses

While this is also considered an operating expense, there are some specific nuances to payroll that I wanted to cover. First, you want to make sure that you are recording the GROSS wages (not net pay as wages) and the EMPLOYER taxes (not total taxes paid, as that will include the employee deductions) as your expenses. 

Often times, when you use a payroll provider such as Gusto, ADP, or Paychex, they withdraw the Net Pay in one payment, and total taxes in another. If you record those amounts as your expenses, your expenses will not match the W-3 issued at the end of the year and your tax preparer may have some additional questions for you.

You are also allowed to deduct any employee benefits that are paid for by your business, but be sure that only expensing/deducting the portion that your BUSINESS pays. If the employee covers any portion of it through a payrolls eduction, those portions are not a deductible expense.

Types of Spending Activities that Affect Your Balance Sheet

As a quick refresher, the balance sheet reflects all of your business assets (things you own), liabilities (things you owe), and equity (the book value of your business). For a quick refresher on the balance sheet, you can go check out this post.

Inventory Purchases

As a best practice, the purchase of inventory for your shop store should be recorded as an asset, meaning that it is not shown as an expense on your income statement. Instead the cost of that inventory is transferred from being asset to being an expense when that inventory is actually sold (known as Cost of Goods Sold). 

Still scratching your head while trying to understand the inventory vs cost of goods sold? Read this.

By properly accounting for your inventory, you will be able to clearly see your margins, and you’ll be able to see if what your current markup is enough to help you cover all your overhead expenses.

While the IRS DOES allow you to deduct the full cost of your inventory when you buy it, I still always encourage you to follow the proper inventory tracking in your bookkeeping to help you make smarter business decisions.

Paying Yourself through Draws

If you have elected to be taxed as a corporation (either an S Corp or a C Corp), a majority of your earnings will be paid through a payroll salary. For everyone else (and for any amounts you want to pay yourself over & above payroll if you ARE on payroll), you will pay yourself through what is called an Owner’s Draw. These amounts are NOT a deductible business expense, and are recorded under the Equity section of your balance sheet. 

If you’re still not sure how you should be paying yourself as a business owner, feel free to read this post for a more in-depth explanation.

You will also use this category if you ever accidentally (or purposefully) use your business account to pay for something personally. To make sure those purchases aren’t recorded as business related expenses, you’ll also use the Owner’s Draw account.

Asset Purchases

Occasionally you may need to purchase some more expensive items for your store – computers & point of sale equipment, new shelving displays, or maybe you even buy the building your store will be located in!

As a (very) general rule, anything that costs over $2,500 will be capitalized instead of expensed, meaning that it’s going to be reflected as an asset on your balance sheet. The cost of these items is then going to be expensed through a process called depreciation. 

There are special tax laws in place that state how long the cost of the asset must be depreciated (expensed) over, for example, computers are spread over 5 years. There are also special tax “bonuses” in place that may allow you to deduct more depreciation expense in the first year that you purchase it. It’s important to work with a tax professional in these cases to make sure you are taking the most tax advantageous route for you and your business. 

Transfers

This is simply moving money between 2 separate business accounts, like from your checking account to a savings account. These types of transactions are not deductible, and are simply reflected by moving the money from one asset (bank account) to another.

Types of Spending Activities that Can Affect Both Statements

Payments Towards Liabilities

Before we jump in here, it’s important to note that this will depend on the TYPE of liability payment you are making. If you’re simply making a payment towards a credit card, this type of transaction will ONLY affect your balance sheet. But, let’s look at a couple examples that could affect both statements.

Loan Payments – Generally speaking, payments that you make towards a loan or line of credit are going to be broken into an interest amount and a principal amount. When these payments come through your bank feed, the interest portion is a deductible business expense, and should be reflected on your income statement, while the principal portion is NOT deductible, and simply lowers the liability balance that’s reflected on your balance sheet. 

Sales Tax Payments – As a general rule, the amounts that you pay to the state are not a deductible expense, because the sales tax you collect from your customers is not income. When you collect these amounts, they go into a liability account, and the payments out come from that same liability account.

Conclusion

Understanding these different types of spending activities in your business, and the various tax implications of each can help you ensure that your bookkeeping is accurate throughout the year for a stress-free tax season! It will also help you make smarter business decisions when you’re basing your decisions off of true data. 

If you feel you need a little more guidance and step by step videos on how to actually track each of these activities in Quickbooks, then check out my signature program, Shopify Bookkeeping Made Simple. Module 2 in the course walks through each one of these in details so you can be confident that every single dollar you spend in your business is being tracked accurately to maximize your tax deductions. 

Feel free to reach out if you have any questions or need personalized assistance with your own boutique’s finances.

Here’s to finding your own version of freedom,

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