5 Reasons Separating Your Business Money and Personal Money is a Must
Stop me if your accountant has said this before… oh, really, they have? Are you sure you don’t want to read further?
Of course you don’t. There is a “smoke in the eyes” frustration of many entrepreneurs. It is the confusion of spending business money on personal expenses, intentionally or unintentionally.
It is a huge hassle to keep your books in order. If you do not take the time to make that important distinction between your business and personal accounts, chances are it could cost you down the road.
You probably know these, but in this post, I will break down 5 stupid simple reasons to keep your business money separate from your personal.
What is the Difference Between Business Money and Personal Money?
Before we get into the meat of the problem, it is important that we fully understand the distinction between personal money and business money. A business is a profit-seeking enterprise. The objective of a business is to make money. Therefore, the expenses of the business must be linked to that goal.
A basic accounting litmus test to determine whether an expense is legitimate for the business is to ask yourself whether or not the expense is ordinary and necessary. Do you ordinarily buy a round of drinks for a group of strangers when you close a deal? Is it necessary for your business to buy those drinks? These are simple questions. If buying those drinks is not ordinary or necessary in the course of doing business, then it is a personal expense, so is buying groceries, dining out, and accidentally using your business card at the home store.
When you put personal expenses on your business card or pay for them with your business account, you are comingling business expenses with personal expenses. This comingling is a telltale sign that your accounting maturity is in a remedial stage. So, without further adieu, here are five reasons you want to keep your business money separate from personal money.
#1: To Be Effective, Financials Need to be Clear.
You want your financials to be in a clearly defined and understandable format. You want clarity for yourself, and you want clarity for other entrepreneurs and financiers viewing your business. This includes banks who may want to finance you or private equity firms who want to purchase a part or all of your business.
When you comingle your personal and business expenses, you create a situation with less clarity in your accounting. Banks and financiers want full clarity. They want to know exactly what they are investing in. Comingling your expenses may put the financial future of your company in jeopardy because you are intentionally or unintentionally muddying the water about what your company does, whom it serves, and why it exists.
On the other hand, when you have clearly separated personal and business expenses, those same entities have a higher level of confidence in your accounting. This will directly influence their opinion of your business acumen because they can see where you are making money. They will be more likely to do business with you because they have a better understanding of the future viability of your business.
As a former commercial lender, I can assure you that when a banker can trust the accounting, there are more and broader avenues for financing. The client is simply taken more seriously than someone else who uses their company as a personal piggy bank for their expenses.
You may find accounting dry, or an afterthought that becomes a nuisance once a year when you must deal with it. That may be how you think of it. But banks, financiers, and private equity firms that you want to do business with are paying attention to your financials.
That is what they do. They do it every day, all day long. When they see someone come walking through the door with an enormous number of distributions and personal expenses, they flag it immediately.
#2: You Can Get Cash Back on a Personal Credit Card.
Do not fool yourself into thinking you are actually doing good by using your business card instead of your personal credit card. Believe it or not, the same cash-back rebates that you can get on your business card are also available on your personal card. Getting cash back on the business card is no excuse to muddy the water.
#3: Cleanup is a Nightmare.
In order to clean up using your business card for a personal expense, you may have to bonus yourself through payroll. In the long run, this will cost more time and money than it is worth. Bonusing through payroll requires painful payroll taxes (that otherwise would not exist) on top of your spending.
You now have to pay 15.3% just in FICA taxes, in addition to federal and state withholding, and may even be required to contribute to your 401k to cover the money you spent, giving yourself a bonus. You do not want to do this. Use your personal card. It is a whole lot cheaper.
#4: Audits are Costly.
If you are audited, in any fashion, you must provide documentation of what you did, where you did it, and why. If you are out having fun and using your business card to go eat or hit up the bar, you need to remember that if you get into an audit, you must justify those expenses. It is not just IRS audits you need to worry about either. The state can also audit you. And believe it or not, state audits are often more aggressive.
You must justify every single purpose for a simple meeting in which that business card was used. Who was the meeting with? What was the intention of the meeting? How long did it last? They want to know every detail. If they think you have been reckless with how you have spent your business money, then everything is under the microscope. The letter of the law states that you must account for every penny of your business expenses.
If you get into an audit, it will not be pretty. It will not be inexpensive. The IRS and/or State will throw penalties at you. You will be fined. And your accountant will charge you more because it is time-consuming and difficult to review all the information necessary to track your expenditures. You may even need to hire an attorney, because you may create a liability by piercing the corporate veil.
#5: Piercing the Corporate Veil is an Unnecessary Risk.
You want to be able to easily demonstrate that your business is a corporation or an LLC. Not just in name but also in fact and appearance. Business owners need the protections that those designations provide. When you lose those protections, you may subject yourself and others to legal actions, debt liability, loss of credit, and more. Needless to say, one of the ways you can pierce the corporate veil is by mixing your personal money with your business money.
If a court determines that you have pierced the corporate veil, this can create a legal liability. Any lawsuit involving your company can now involve you personally. That means creditors, the government, or anyone else filing suit against your company, can make claims on your personal assets. Not just the company assets. Other shareholders in your company or the company board of directors may also become personally liable. The best way to prevent this is to run a tight ship. Do not mix your funds. Keep your books clean.
Be Diligent, Consistent, & Ready.
Those are just five reasons to keep your personal and business finances separate. There are more, but you get the picture.
Your financial statements need to be defined and clear, “chiseled” if you will. Think of them like a solid beach body. Tone your financial statements like you would your abs. Show them off to the world at any given time.
Work out all year on your finances. Be disciplined, and do not skip a day. When you show your financial statements to a potential partner, they will look good, beach-body good. Go ahead and show off those six-pack assets.
You never know when you will need to impress someone.