What I found common, in my interactions with a good number of entrepreneurs is that they find it difficult to separate their business finances from their personal finances.
More often than not the entrepreneur uses proceeds from his business to finance family-related needs. This practice is a major reason why businesses fail.
It is important that entrepreneurs understand the difference between personal finance and business finance.
Personal finance deals with the management of an individual’s cash flow – how you earn income, how you spend what you earn, how you invest and how you manage your risk over time.
Simply put, personal finance is concerned with how an individual build and grow his/her financial net worth.
On the other hand, business finance refers to the management of finances of organizations, i.e., business or corporate entities and institutions.
Business finance deals with how a business organization arranges its affairs to achieve its financial goals. These goals can be expressed in terms of cash flows, sales, profits, and operating expenses.
Every business owner, irrespective of its size, must understand these differences and integrate them firmly into his every day business life.
Importance of Separating Business from Personal Finances
You probably might have come across the statistics that show that 8 out of every ten new businesses fail between their first and second anniversary but what many entrepreneurs fail to realize is that commingling of business finances with personal finances is one of the major reasons for this level of business mortality.
Apart from helping avoid business failure, separating business finances from personal finances is important for the following reasons:
#1. Your business will be perceived as one that is professionally run and this will help to attract quality clients. No serious customer will want to deal with a business owner who does not have a clear demarcation between his business affairs and personal affairs.
#2. Tax issues – Separating business and personal finances will help you manage taxation matters properly. For example, you may not be able to make claims for some otherwise allowable business expenses for tax purposes, if you commingled business and personal affairs and thus, end up paying more taxes.
#3. It helps to enhance the business entity concept which is the bedrock of double entry book-keeping. The entity concept stresses that the transactions of a business entity must be separately recorded from those of its owners. In doing so, the assets and liabilities of the owners are strictly excluded from that of the business.
#4. Audit purposes – Though auditing of accounts may not be statutorily required for a Sole Proprietor or small enterprise, it is a good business practice to have external auditors review your records and append their stamp to show that records are being properly kept.
Such reviews will come in handy if you need investors to come into your business or require funding from banks, development and such other financial institutions. Sometimes, it may be a necessary condition for participation to bid for business opportunities.
If your business records and commingled with personal finances, auditing your books will be a difficult task.
#5. If your business runs into troubled waters, you will be protecting your personal assets from being used to settle business debts if both finances are clearly separated
So you see, separating your business finances from that of your personal one is the beginning of sound financial management practices that protect both you and your business.
How to Separate Business Finances From Personal Finances
Right from the time you are planning to start a business, no matter how small the scale, you should incorporate programmes that ensure that you do not commingle personal and business finances.
The following steps, if taken will ensure you achieve the needed demarcation:
#1. Register your Business – Registering your business is the first step to creating a separate entity, distinct and distinguishable from you the promoter of that business. There are different types of business registration and it will help if you discuss with your lawyer or consult with an expert on which type of registration that is suitable for your business.
#2. Open a business bank account – You must open a dedicated account for your business and ensure that only business related transactions pass through this account. Family or personal related expenses must be routed through your personal account.
#3. Pay your self a salary – Yes, you have to place yourself on a salary just the way you would be paid if you were working for someone else. The mistake most entrepreneurs make is constantly dipping their hands in the company’s till to take money for family and personal needs. Most times, such takings are not accounted for. To avoid this, decide on a salary and create for yourself a payday and stick to it. Budget your personal expenses on this salary and if for any reason you need additional money before your pay-day, treat it the way you would if such request was made by your staff.
#4. Keep proper records – fortunately keeping proper records is no longer a cumbersome task with the availability of cheap or in some cases, free accounting software. If you can afford it, engage a book-keeper to handle this aspect of your business even if it is on parttime basis.
#5. Track shared expenses – It is very possible that certain expenses may cut across both personal and business depending on the structure of your business.
For example, if you operate from home, you must decide what portion of the house rent and utility bills should be ascribed to the business. Expenses on entertainment, food and travel should also be so tracked and clearly separated.
Finally you have to be disciplined. Set up a system that separate your business affairs from your personal affairs and stick to it and let this discipline runs across the entire family spectrum.