As a seasoned Xero Partner and certified advisor at Digit, I've seen it all when it comes to the wonderful ways in which people can set up Xero. Whether it's been done by the business owner or their accountant - here are some of the common mistakes we see with Xero setups
Rolling with the default Xero setup
Xero has designed their customer onboarding to make it simple and easy to get started. It's easy to breeze through the Xero setup wizard. Click, click, click. All done! However getting those first few steps right is critical to your business, and the first place to start when setting up Xero is your chart of accounts.
Often we see people roll with the default vanilla Xero chart of accounts. Thing is, there is nothing vanilla about your business.
For example - your business structure will influence the correct setup of some liability and equity accounts (such as Drawings) and some accounts might or might not be required (like Dividends). Before running with the defaults, stop and consider what are appropriate accounts for your business to have and customise it
Having a messy chart of accounts
First of all, if you're not sure what a chart of accounts is, think of it like this ...
Imagine you have a set of buckets, and balls that you want to sort into those buckets. Some balls are red, some yellow, some furry, large, and small. So you label your buckets and sort the balls by type, so that you end up with balls of the same type within each bucket.
That in effect is accounting in a nutshell. The balls are transactions that you classify by what they are, and the buckets are account codes. The collection of buckets is your chart of accounts. Simple right?
Once you've got the right accounts for your business structure, the next question is this - What do you want to measure? What are your buckets?
There are two things to consider here -
- How much detail is enough to give you the insights into how the business is performing?
- How much detail is too much that it creates work for you?
Like yin and yang, there's a balance to be found in how you set up your chart of accounts.
Ideally you want to have just enough detail to manage the business effectively (setting up an account for your main income types for example) but not so much that you're constantly making decisions about the best bucket to use.
You also want your accounts to be logically grouped. Xero does this through well numbered account codes - 2XX are revenue, 3XX are Cost of Goods Sold, 4XX are expenses. There's method to the madness, and it helps ensure your accounts are beautifully organised
Getting the taxes wrong
While we're on the topic of accounts, review your tax codes are setup in Xero.
If you're Australian, your business may or may not be registered for GST. Confirm that the accounts are set up appropriately. If you're not registered for GST but your accounts show GST on Expenses, or GST on Income - you've taken a hard left. They should be BAS Excluded. If you are registered for GST, then your balance sheet accounts should be (generally) BAS Excluded, and your profit and loss accounts (generally) have some form of GST treatment attached to them (even if it's GST free)
Also confirm your financial settings. If you're registered for GST, confirm that the GST reporting basis reflects whether you report GST to the ATO on a cash or accrual basis.
What is the difference between cash and accrual reporting? Simplistically this - If you report GST from when cash hits your bank, that's a cash basis. If you report GST from when you send an invoice or receive a bill, that's an accrual (or non-cash) basis. Typically businesses with an aggregate turnover more than $10 million report on accrual, small businesses report on cash *
Missing out on tracking
Tracking categories are a hidden gem in Xero. They are a set of labels you can use to classify transactions independently of the chart of accounts.
To understand it, imagine if your balls had labels on them for a brand - some are Spalding, some Titleist, some Wilson, some Dunlop. Now imagine you could group together the balls by brand while still noting the bucket they are in. That's tracking.
In Xero you can set up to two tracking categories, and each category can have up to 100 options. Then when you create a spend money, receive money, invoice, bill, journal or run payroll - you can assign that transaction to both an account, and a category.
Tracking categories are best used for when you have profit/cost centres, different departments, or different activities of the business that you want to measure. Things that are broad in nature and don't change often.
What it allows you to do is run a profit and loss report on a specific category, without resorting to using your chart of accounts for that amount of detail. One Sales account, two different areas of the business. Brilliant!
We sometimes see people use tracking categories for jobs. Please don't do this. Xero isn't designed to handle Jobs well, and if you want job level profitability, you're better off exploring Xero Projects or Job Management addons like Workflow Max, SimPro, AroFlo or others.
Messing up the bank feeds
When you bake a cake, there's an order to it. You mix the dry ingredients, the wet, combine them, grease a tin, and throw it in a preheated oven. Or at least that's how I imagine it, baking is not one of my superpowers.
The same applies to setting up bank feeds in Xero. There's a sequence to follow to bake that cake.
First, add the bank account in Xero. Easy. Then follow the prompts to activate the bank feed. Depending on your bank, that might require you to fill out a form, or enable it online through internet banking. Once switched on, wait until transactions start appearing in your accounts.
You might be thinking 'what about the transactions that happened before then?' and if you are, good spot!
The trick to setting up Xero correctly is importing in the bank transactions that took place between the day Xero is set up to start (for example - a new financial year) to the day the bank feeds went live. In the Xero world we call it 'filling the gap'
Simply log into your internet banking, export the transactions as a CSV, import them into Xero - and you're done 👍
Forgetting the opening balances
When you set up Xero, you decide on a date the accounts start. Best-practice is to align this to a financial year, failing that a compliance period like a BAS, failing that the start of a month. Either way, you choose the date that Xero 'starts'
If you've been running your business a while though, that start date won't be a blank slate. You'll have money in the bank, balances in your accounts, and essentially a picture of your finances at a point in time.
Xero allows you to bring in this picture as a conversion balance. There are two things to note about conversion balances -
- Unless you're a brand new business that has done nothing, you'll have outstanding amounts to set up in Xero
- The amounts should balance
Sometimes we see that people have forgotten to set up a conversion balance (then wonder why their bank accounts in Xero don't agree to the bank statements) or have amount that don't balance.
Not bringing in outstanding invoices or bills
Related to the conversion balances, if you have customer invoices that are unpaid at the point in time you set up Xero, or bills that you haven't paid yet and are still owing - import these into Xero.
The individual invoices should sit within either the invoices or bills sections in Xero, and the total value of those invoices should be part of your conversion balances listed under accounts receivable (for sales invoices) or accounts payable (for bills)
Using personal bank accounts
Don't. Xero reports on the financial activity for a business, as a distinct and unique entity. Mixing business with personal transactions gets messy real fast. Even as a sole trader when all income is essentially yours anyway, it's better to have some separation. After all, those tinder expenses don't relate to your business performance.
Best practice is to only set up bank accounts that are owned by the legal entity in Xero. And if you're a sole trader? Consider setting up some bank accounts that you ONLY use for your business to create clear boundaries.
You can see that setting up Xero is more than simply following the bouncing ball. It takes some insider knowledge to get right. So when you're ready to get started on Xero, consider working with an expert partner to set it up with you. And if you already have Xero setup and feel that something isn't quite right - check to see if you've made one of the common mistakes!
We offer complimentary reviews of your Xero setup, along with deeper dives to help you uncover what you can improve in Xero