When you first started your business, like many entrepreneurs, you may have used your personal assets for startup capital or may have secured a business loan based on personal assets. As your business grows, creating a clear boundary between your personal and business finances is crucial to staying on the right side of the law.
Even if you’re just starting out, it’s essential to split up these two parts of your money life. Treat your business, no matter big or small, like a viable entity.
Don’t know where to start with separating out your personal and business finances? Let’s start with expenses.
An expense can be defined as money spent or cost incurred in an organization’s efforts to generate revenue which is also known as the cost of doing business. However, there are expenses that are carried for satisfying our wants and needs that are of personal nature and do not result in any incremental revenue.
As you navigate business financing, it may be tempting to use your personal finances to help out when your business needs a boost, but that is not always the best solution in the long run. Separating your personal and business finances can help ensure you treat your business like the independent entity it is while safeguarding your personal finances.
Why Do I Need to Separate Personal And Business finances?
Though there are many benefits to keeping your personal and business finances separate, two of the main reasons you should draw a line in the sands of finance are for tax and personal protection purposes.
It is much easier to keep track of business expenses for tax purposes if you use a separate business account. Once you have your business checking account, keeping track of things like expenses is essential to properly file taxes. Remember, from office expenditures to operational and inventory purchases, every receipt counts. When it comes time to file your taxes (or hand everything over to your accountant), a thorough collection of business-only information is going to save you a lot of time and a significant amount of stress.
Separating your personal and business finances is important for tax reasons. However, separating your personal finances for the sake of your personal security is perhaps equally, if not more, important. Using your personal finances to back any entrepreneurial venture can be a risky business and not just because of the initial financial gamble.
Entrepreneurs often wind up signing personal guarantees for leases, loans, and lines of credit. Sometimes that’s necessary, especially when your business is young and hasn’t established a strong business credit rating. But your goal should eventually be to avoid personal guarantees as much as possible. The way to do that is by building strong business credit to give lenders confidence that your business can and will repay its debts.
How to separate your personal and business finances?
Make it official
Consider establishing a partnership firm, limited liability company or a private entity for your business. You can refer to the Corporate Affairs Commission’ website or sit down with your advisors like CAs, lawyers, CPAs, or financial planners and determine what entity makes the most sense, how this business will impact your taxes and financial planning.
These business entities will also give your personal finances a new level of liability protection, which could come in very handy if your business is ever sued.
Classification of finances
Keeping separate records of accounts, one for personal and another for business nature of finances is one of the oldest methods. However, maintaining two separate books of accounts can be cumbersome and are prone to errors. Hence, proper classification of heads of accounts is a must for keeping personal and business expenses and incomes separate.
For example, you have purchased two desktop computers of which one is to be used at home. Then in such case, the cost of that one computer to be used at home should form part of the amount drawn out of business for personal purposes and not of business block of assets.
Open separate expense accounts
If you are paying for some services or products which are used for your business as well as your personal needs, then you must keep in mind to open separate expense accounts due to the similarity of expenses. Separate bank accounts and credit cards
Separate bank accounts and plastic currency such as debit cards and credit cards enable you to maintain a tally of such finances separately, and there will be no need to group and analyze each and every expense/income from the bank statements, as the process is lengthy and cumbersome.
For example, open a separate bank account and a credit/debit card for that account and it should be solely used for business expenses. Same goes with your personal account and plastic cards, that they should not be used for carrying out business expenses.
Pay Yourself a Salary
One should fix a particular amount to be withdrawn every month from the business as personal drawings for carrying out household expenditure. Open another separate personal account meant only for the purposes of carrying out expenses of personal nature. By adopting this practice, the amount withdrawn as drawings will not affect the profit and loss statement of the business and separation of accounts and bank statements will ultimately provide clarity and proper maintenance.
Separate loan accounts
Imagine, you want to avail home loan from a bank in which you even have your business account with, and the bank official offers you to adjust interest periodically from your business account. This looks good as you will not be required to keep track of your periodical payments and the bank will do the same for you. However, a house is a personal asset and interest on such assets if adjusted from the business account will ultimately end up forming part of business interest expenses.
Therefore, one should adjust the same from the separate drawings account in the bank and linking with a business account shall be avoided.
Hire a professional accountant
If you want to manage finances, you ought to hire a professional accountant. A professional accountant will guide you through the classification of expenses, accounting treatment, taxation impacts of transactions, etc. Hence, hiring a professional accountant will enable you to keep your books clean and clear.