Running a business demands precision and discipline, especially when it comes to financial matters. One common pitfall that entrepreneurs should steer clear of is the commingling of business and personal funds. This practice occurs when business finances and personal expenses become entangled, leading to a host of problems that can have serious repercussions for your company. Many business owners comingle funds as they are just starting a business because they are unaware of the proper way to handle the bookkeeping for a small business. It is important to understand how comingling occurs and the pitfalls associated with it.
Commingling of funds means that you’re using business funds to pay for personal expenses, or you are using personal funds to pay for business expenses. Commingling can happen in any of the following:
Checks made payable to your business from a client are deposited into your personal bank account. In most cases, the bank will not allow you to deposit a check made out to the business in a personal account. However, there can be exceptions to this, so it is important to be mindful of the consequences.
Making withdrawals from your business checking account to cover personal expenses without proper documentation is another red flag. Whether it’s electronic transfers or written checks, this practice muddles financial records and can lead to complications down the line.
Depositing personal money into your business account to pay for business expenses can cause confusion for your accountant or bookkeeper. This type of transaction is actually considered a shareholder loan, and it should be recorded appropriately.
Using a personal credit card for business expenses to earn points can create issues in two ways: it is considered debt to the business owner and not the business, and it becomes a tedious task for someone to separate business expenses from personal expenses every month.
Aside from the accounting nightmare that commingling business and personal funds creates, there can be legal consequences as well.
Difficulties In Accounting
When personal and business funds are mixed together, accounting becomes difficult and inaccurate. When personal expenses are included in business expenses, the expense side of the profit and loss is overstated, and net income is understated. This inaccuracy makes it harder for future investors and creditors to understand your true financial picture, thus making it difficult to fund future growth.
Tax deductions Issues
Deducting personal expenses as business expenditures without proper documentation leaves the business vulnerable to audits and potential legal ramifications. Furthermore, the business may be missing out on tax deductions and credits due to the lack of clarity between a personal and business expense.
Asset Protection
One of the fundamental benefits of a business structure is the protection of personal assets in case of bankruptcy. However, commingling funds undermines this protection through a concept known as “piercing the corporate veil”. In this case, a court may argue that you and your business are not separate, and personal assets may be at risk.
Legal Consequences
Finally, commingling funds can lead to serious legal consequences, such as:
Theft Allegations: Fellow owners may view commingling as theft.
Fraud Concerns: Taking out a business loan and using the funds for personal expenses can be construed as fraud.
Industry Specific Laws: In certain industries, commingling funds is illegal.
While it may seem tedious to keep business records separate from personal funds, it is absolutely crucial for maintaining financial integrity and protecting your company’s liability. Implementing clear financial practices and keeping meticulous records will help ensure the success and longevity of your business.
Cessie Cothran, MBA
Combining the CFO Advisory with tax strategy creates the best opportunity for financial success. We like to call it being perfectly Aligned. Our clients know they have us as a partner, helping them to feel secure about their financial future.
Email Me: Cessie@alignedcpa.com