The most overlooked management tool in the average small business is the bookkeeping ? until the Income Tax service calls for an audit. Then the small business owner is left scrambling to gather up their records and try and organize them in a professional manner. This is often ?too little too late? for most business owners.

The most important thing to remember is that you are a business. It doesn't matter if you are investing $100 a month, or making candles to sell at a local flea market. A person who provides day-care for children, or the elderly, in their home is as legitimate as a corporate lawyer's office in the downtown core. A person who writes web articles, or has a drop-ship ecommerce website, or a forum poster must all keep tax records for their business.

The Income Tax Auditors are not dissuaded by comments such as:

It is just a hobby

It is not full time

I work for a company in another country.

I do this for fun

I am just helping my in-laws

I don't make enough to register as a real business

If you are engaged in a task that produces revenue, then you are in business, and all the tax laws apply to you, regardless of how little you make, or how occasionally you work.

Why Are You Being Audited

The first step is to understand that a ?letter of audit? does not mean the Revenue agency found something wrong. Sometimes the government picks businesses within a certain industry at random for an audit. They do this to build a statistical base, and economic information needed to measure the Gross National Product.

Even if there is a problem, it rarely means that you are in legal danger. Sometimes the paperwork did not add up. The Revenue agency may just want to make sure that your mistake is not intentional, or far greater than they first expected.

How To Prepare for an Audit

Preparation for an audit starts years before a letter lands on your desk. The first step is to register the business and find out whether retail tax applies to the services and products offered. This is especially important if the income is generated in another country.

The first step is to use a reputable bookkeeping system. This may be a bookkeeping journal, or a software program. The computer programs are the easiest for new companies to use. They generate reports automatically.

Keeping records of income and expenses is only half the task. A small business owner also needs to keep a record of the time spent with the business. Many business owners use day planners, or even a blank notebook to keep a daily record of their activities. This is one of the best tools to prove that you've been engaged in a full time business, and deserve to claim all tax benefits, especially if the company has not started generating revenue at the moment.

The third tool needed is a business account. All income should be deposited in this account, and all money should be paid in the form of a check that can be tracked.

Organize Paperwork

One of the worst things you can do is drop a shoe box of receipts on the auditor's table and hand them some hand written balance sheets. It is better to have an accordion file, divided by month, or weeks, even if there is only one receipt in each section.

Each receipt should have the ?journal number? printed on it, and each journal entry should have a receipt number in the description box. This will make it easy for the auditor to find what they are looking for.

This is most important for questionable receipts. An expense $1000 for cleaning may look suspect, but if the receipt is filed with a note explaining that your refreshment table spilled soiling 2 people's suits and the rug at an office complex, complete with contact names, the auditor will quickly overlook the expense.

Paper Trail

The paper trail is the life saver. Always have a paper trail. Cross reference things. If you are using a tool such as Microsoft's Business manager, you can assign tasks a number, use this number on receipts, keep a journal of time spent, cross this with people's names, and then use the numbers in the bookkeeping journals.

A paper trail is just that, a method of tracking a project, purchase, or sale. The better the paper trail, the quicker an auditor will dismiss your case and let you go home.