How to Separate Business and Personal Finances

The two biggest hassles for most entrepreneurs are accounting for expenses and paying taxes. It’s not a coincidence that these things are inextricably linked. Business expenses lower your taxable profit.

Failure to capture all your business expenses results in overestimating your profit and overpaying income tax. But mixing personal expenditures with your legitimate business costs creates bookkeeping confusion and may trigger scrutiny from the tax authorities.

The fact is, not all business purchases are paid from the company checking account. You likely use a personal credit card and spend some cash. Especially complicated is adding to your bookkeeping a home office or business use of a personal vehicle.

Adhering to specific accounting procedures ensures you take the correct tax deductions for using personal funds or credit cards for business costs, as well as for contributing personal items to the business. Use the following principles to guide your accounting practices.

You Are Not the Business

Think of your business as something separate from yourself. In fact, this is exactly the legal structure if your business is a corporation or partnership, or an LLC treated as one of these entities for tax purposes. When you spend money on your credit card for business, simply turn in the receipts for reimbursement by the company. Of course, the business doesn’t need to actually reimburse you as it would an employee. Since you’re the owner, these personally paid items count as capital contributed to the enterprise.

Personal cash used for business must be accounted for by promptly providing receipts for reimbursement or, rather, capital contributions. Holding these for too long is a mistake because they could be misplaced. Or you might not remember what exactly was purchased, which means the expenses cannot be properly recorded in the correct bookkeeping category.

An even better practice is having a dedicated credit card for business purchases. Remember, just because you have a card for your business doesn’t mean everything you buy is a tax-deductible expense. Personal uses of the dedicated business credit card become capital distributions from the business. These make your company poorer. You don’t want an investment in a business that’s losing wealth.

Things for You and the Business

Special tax rules apply to business use of your personal vehicle or home. Don’t expect reimbursement or capital contribution credit for all your gasoline purchases simply because you drove around for business.

Actually, you may be cheating yourself out of a larger tax deduction by not having the crucial record of business miles driven. Fuel is only one of the expenses considered when using the standard reimbursement rate established each year for business miles driven.

Home offices may or may not be tax-deductible expenses, depending on several circumstances. Track your home expenses separately from business costs. A calculation is made at year-end based on those amounts and the percentage of your home used regularly and exclusively for business.

Lastly, when you make a major business purchase with personal funds, especially if money is borrowed, advice from your tax accountant is vital. The entire cost, along with any loan, must be recorded in your bookkeeping records. Also, the accounting for tax purposes is very precise when you acquire some things that are used both professionally and personally.

Building an Emergency Fund for Your Business

Every business needs a rainy-day fund, but a commitment to action for accomplishing this objective is often elusive. Waiting to see how much money is left for your virtual piggy bank after paying all the bills is not a viable solution. There’s never enough unless you take steps to control spending.

An effective method to build a cash reserve is to make a place in your budget for the emergency fund as if it were another vendor bill. Adding this cost of doing business may seem impossible at first. But close examination of your recent spending categories is certain to reveal some areas for expense reduction.

Look at the trends in your business spending. Are some types of expenses rising? Buying more is common when a business starts generating a little more revenue. Finding your previous spending level and returning to it merely requires inspection of historical expenses. Perhaps your vendors’ prices have increased. This is an opportunity to negotiate volume discounts, find different vendors, or raise your own prices.

Most important of all in creating an emergency fund is putting aside the additional income you make from an extraordinarily profitable month or period of the year. Completing a particularly large project or seasonal phase means you have more cash to retain for future lean periods.

Keeping a separate bank account is usually best to avoid the temptation of extra spending. This same account functions as a place for those ongoing deposits of small fixed amounts every month until the inevitable disaster strikes. When it does, your rainy-day account provides the perfect protection.