Blurring the lines between business and pleasure is not always a good idea. It’s not classically harmful, but it has its own disadvantages. The same is true for business and personal finances.
When you’re starting a business, one of the best money advices you will get is to keep your business and personal finances separate. While it may seem like a practical way to manage a startup venture, the situation can quickly go out of hand—particularly at tax time.
What is Mixing of Personal and Business Funds?
So, how exactly does mixing personal and business funds look like? Here’s how most financial modelling companies put it:
- Taking money from personal accounts to pay for business expenses
- Writing business checks for personal use
- Depositing checks made payable to your business into your personal account
- Using the same account for personal and business transactions
- Transferring money between business and personal accounts without documentation
Ease is probably the main reason why you’d prefer to keep your business and personal finances in one place: you can see all the money that goes in and out, making it easier to keep track of expenses. But, this sense of ease will eventually fade when it starts to lead to problems with your taxes or asking a customer for payment.
The Potential Consequences of Mixing Personal & Business Finances
If your business is a corporation, it is a separate legal entity from yourself. It means you must maintain a separate account for it. Conversely, if you operate under sole proprietorship, there’s no legal distinction between your business and yourself. However, it remains best to keep your accounts separate.
It should make the process of tracking your cash flow easier when facing an audit or legal issue. In case someone sues your business, your lawyer would be hard-pressed to present your case with legal documents. You also risk putting your personal assets on the line, despite them being a separate entity from your business.
Imagine this scenario: you look at your account, see there’s money there, and think you can spend it for personal use. By the time you have to pay for your inventory, you are surprised to discover that you don’t have enough money for it.
Your cash flow situation is already hard to predict. But, you make it even more challenging when you transfer money between accounts frequently, resulting in a mess of data. Keep a separate account for your business—it provides an instant overview of your profits and losses without much effort.
When you pay for your personal expenses with a business account, you make it harder to identify what expenses qualify for business tax deductions. As a result, you risk over-claiming tax deductions or miscategorising personal expenses as for business, which may lead to penalties in the event of an ATO audit.
This problem is compounded when you don’t categorise your expenses. By the time you have to file for taxes, you’ll spend more hours than necessary to prepare your documents, only to discover that some of them are missing.
There are far more reasons to keep your personal and business money separate:
- It can help you establish a business credit
- it makes you look more professional; and
- it saves you time and money
All these statements should be enough to put your systems in place and the good news? It takes just two steps to separate your business and personal finances.
- Register Your Business – Whether you start as a sole proprietorship, registering your business will help you establish legal grounds that separate your personal and business financial obligations, taxes included.
- Open a Separate Account – Besides helping you stay organised, a separate account also allows you to track how well your business is performing and identify areas you can improve. By the time of tax filing, it’s easier to pull out your records, without spending more time separating your non-business expenses.
What do you think of mixing personal and business finances? Let us know by leaving a comment below!