Not keeping the personal and business funds separate is one of the most common mistakes made by new entrepreneurs. If you’re a business owner, blurring the lines between business and personal expenses can be very tempting. This mistake is often the prime target for taxation scrutiny in audits.
Your personal finances can easily get tangled up with that of business finances. The worst case is when you spend your business revenue as if it is your own income. I’ve seen new entrepreneurs who immediately switch to a luxury branded car when they see the lump sum payment cashed into their bank account. The temptation is hard to resist if you don’t know how to manage cash flow.
First and foremost, business should be considered as a completely separate identity. No matter what type of business you’re running, keep in mind that this separation needs to be addressed starting from Day 1.
Why is it not wise to mix your Business Money and Personal Money?
Avoid Piercing the Corporate Veil
Let’s say you’re operating a corporation (Sdn. Bhd) or a LLP (Limited Liability Partnership). When a clear distinction cannot be found between your personal and business expenses, you might be held responsible for company debts. This is called Piercing the Corporate Veil.
To put it simply, if your business falls in a crisis with any amount of money and the courts cannot determine the plane of intersection between your personal and professional finances, your assets might face the risk to be seized to meet the demands of the creditors.
So a little effort here can save you from a blatant disaster in the future. Consult a legal advisor if you need more clarification as I don’t have a legal background to provide you advice.
Maintaining a Professional Reputation
Neither the customers nor the clients feel secure and confident when they’re dealing with a business that seems more like a hobby! When there is no proper separation between the owner and the business, that’s exactly how any business will look like. You would want your business to have the most professional outlook possible. Mixing business and personal finances will never help.
For instance, when a client writes a personal check to you instead of writing one to your business, it’s absolutely natural for the client to feel uncomfortable, although it might work well enough for you.
Refraining from Self-Destruction
You should view your business like an individual, separate and living entity, or you would end up treating it as your personal cash register. This mindset can ruin your business, draining it to a point of insolvency. Even the most profitable industry can plummet to the ground when the owner takes out too much money with no concern for the solvency of the company.
There are many people who would lavishly overspend the business money. Just because you have a lot of money, doesn’t mean you can commit to a luxury car. That’s the recipe for disaster.
Dealing with the Tax Season
It’s highly beneficial to have separate personal and business accounts when it comes to tax preparation. All your business expenses throughout the year will stay separate from personal purchases when you have a business account.
It’s recommended to set some additional money aside before the tax season arrives. You’ll never have to worry about draining your personal account for covering taxes when there is sufficient money in your business account.
Strategy #1 – Track Your Business Expenses Separately
Tracking your business and personal expenses separately is an important component of financial segregation. If you’re raising the startup capital for your business and even if you’re using your own money, a separate budget should be prepared to make sure that you can still cover your individual expenses.
This is true for a one-man shop as well. If you have a tight personal budget, look out for external funding.
Instead of paying for company expenses directly from your personal account, use business credit accounts. For example, if you need to buy a cash register, do it using a business cheque or a company credit line. Similarly, when you want to pay for your own bills using the business funds, write a check to yourself instead of doing it right from the company fund.
This helps to avoid the auditing complexities which can arise if the taxation authority finds that you’re using company money for personal expenses. Besides, separate accounts will also lead to separate taxation.
If you can focus on drawing on the right account for the right transaction, all you have to do is review the bank statements when you need a clear picture during tax time. You can even do the taxes and financial reporting directly from the bank statements if you avoid cash and manage to use only your business debit/credit card.
Strategy #2 – Use A Business Credit Card
It’s difficult to meet the lending requirements when you have a small business or a startup. It’s still worth it to try and get a business credit card. Just like having separate checking accounts, a credit card helps to keep record of all transactions and gives you something to show to the taxation authority when you’re audited.
On top of that, a business card can also give you additional tax deduction. The balance on a business credit card is the only credit card interest that can be deducted for a business expense.
Since you won’t have a financial background when you first start a business, you won’t be able to get a business card. A possible solution is to use a separate personal credit card and use it only for business purposes. It’s justifiable that the interest expenses on the credit card can be filed as business expense. Please consult your accountant for more details.
Strategy #3 – Make It Official
It’s a good idea to establish a separate entity with a private limited company (Sdn. Bhd.) or limited liability partnership (LLP) for your business. Sit down and consult with a team of professional advisors including accountant, tax advisor, company secretary, insurance agents, financial planners etc. to weigh your options.
Explore which entity sounds the most reasonable and how this business is likely to affect your financial plan, taxes and what sort of insurance coverage you should look out for.
Apart from the obvious tax advantage of lower tax rates for corporate earnings, the business entities will also provide a redefined liability protection to your personal finances, which can be really helpful in case your business is ever sued.
Strategy #4 – Proper Documents
Everything should be properly documented. When you’re contributing money into the business – is it loan or investment? When you’re taking money out – is it salary or loan from company? Each and every business-related expense should be clearly documented on paper. Everything should be on receipt.
For example, you went out on a business tour and stayed over at a hotel. This hotel expense should be documented along with your purpose of going out of town. If you spend some money for business entertainment purpose, the entertainment bill should be documented stating the name of the customer you’re entertaining. There should not be any transaction without written documentation.
When you have your utility and grocery bills in the same box with invoices and business receipts, a huge mess will be waiting for you to clean up during tax time. Separate business and personal records can solve this issue. Physical business records, for example – mails and receipts, as well as digital data such as emails, word files, spreadsheets and posts from social media, everything should be on paper.
Your business is definitely meant for you. All your earnings and profits belong to you. They are all your money, but in order to keep the profits streaming, it’s important that you treat your business as a different entity from yourself. When you track all your finances separately, you know exactly where your business money and personal money is going and you can take decisions in case of any critical situations.
In order to become a successful entrepreneur, it requires a huge expertise in different fields. Undoubtedly, a vital feature of a successful business owner is to have a clear understanding of financial management. After all, if you have no money, you have no business!
Striking a balance with your finances is the key to success. Go cheap and you’re not likely to get quality results. Go extravagant and you’re likely to turn up in the red and fall. Be smart, be optimistic and invest in business with the potential to grow and put you in the frontline for success.
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