Separating personal and business expenses
Most business owners have been in this position. It is early days, you are still small and the majority of personal finances are being fed into the business to fund its growth. Several owners will still be of the mindset, let’s wait and see how this grows, before we formalize the business by opening the business account, buying the accounting software and even considering other apps to help.
Other owners will open the business account, yet some expenses will still be paid with a personal credit card, given that the sufficient income is not yet being generated to fund the owner’s day to day expenses and the business. For instance, personal rent is often paid with the company revenue, because this could be the only income the owner is bringing in.
Research has shown that this commingling of accounts is most common with part-time entrepreneurs, network marketers and sole-proprietors. This makes sense as many part-time business owners and network marketers start off with, what even they would consider, a hobby and then it suddenly grows.
At that point, it is a necessity to start taking more responsibility for the direction of the business and to treat the business as a separate entity. Getting it right from the start saves time and potentially a lot of money as well.
Commingling Finance takes many forms including:
- Depositing cheques made out to the business into your personal account;
- Paying personal expenses from your business account or vice versa;
- Sharing one bank account for personal and business transactions;
- Moving money between a personal and business account without the correct supporting documentation.
There are several reasons why you should separate your finances:
- The classification of a business and a hobby
Only a business can claim business expenses. If you are charging business expenses through your personal account regularly, you are potentially creating difficulties for yourself in the future. For instance, if you were to be audited, you may find it more difficult to prove that you are operating a business rather than a hobby. Which could lead to hefty TAX implications.
- Making tax time difficult
TAX time is generally nobody’s favorite time of year so why make it more difficult for yourself. If you mix personal and business expenses, you are going to have to track back through hundreds, possibly thousands of transactions and remember, if they are related to the business or not.
This is very time consuming, frustrating and could result in you missing certain business expenses and paying more in TAX. If your business account contains personal transactions and your accountant is charging by the hour to sort through unnecessary transactions, this is costing you money.
- Missed deductions
As briefly mentioned above, mixing personal and business expenses could lead to missed deductions come TAX time. Trolling through a mixture of transactions when you are under pressure to lodge TAX returns, may mean you will miss a legitimate business expense.
Therefore, keeping your books in order from the start is truly a beneficial practice.
- More serious Implications
Missing a few deductions along the way may not be too serious however, under certain legal regimes, mixing personal and business expenses can have serious implications under a term called Piercing the Corporate Veil.
If you are operating an LLC or Corporation and continue to commingle finances, it may be decided that you were not operating an LLC in a court of Law. Therefore, the protection gained from an LLC could be null and void.
How to avoid Commingling finances:
- Set up a separate Bank Account and Credit Card for the business
- Deposit cheques meant for the business into the business account
- Don’t pay personal expenses from your business account. Pay yourself via Owners drawings, and then pay personal expenses through your personal account
- Don’t pay business expenses with your personal account
- Attach correct documentation to provide a legitimate audit trail when transferring between accounts