Running a business demands precision and discipline, especially when it comes to financial matters. One common pitfall that entrepreneurs should steer clear of is mixing business and personal finances. 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 mix finances when they are just starting a business because they are unaware of the proper way to handle accounting for business expenses. It is important to understand how mixing business and personal finances occurs and the pitfalls associated with it.
How Mixing Business and Personal Finances Happens
Mixing business and personal finances 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 ways:
-
- Depositing business checks into a personal account: Checks made payable to your business from a client should always be deposited into a business bank account. Most banks will not allow you to deposit a check made out to the business in a personal account, but there can be exceptions.
- Using business funds for personal expenses: Making withdrawals from your business checking account to cover personal expenses without proper documentation is a serious issue. Whether it’s electronic transfers or written checks, this practice muddles financial records and leads to complications.
- Using personal funds to pay for business expenses: Depositing personal money into your business account for business expenses can create confusion. This type of transaction is actually considered a shareholder loan, and it should be recorded appropriately.
- Using a personal credit card for business expenses: While it might seem convenient to earn points, using a personal credit card for business purchases creates issues in two ways: it is considered debt to the business owner (not the business), and it becomes tedious to separate business expenses from personal expenses every month.
Beyond the accounting nightmares, mixing business and personal finances has legal and tax consequences as well.
The Consequences of Mixing Business and Personal Finances
Accounting Difficulties
When business and personal finances are mixed together, accounting becomes difficult and inaccurate. Personal expenses recorded as business expenses overstate costs and understate net income. This inaccuracy makes it harder for future investors and creditors to assess your business’s financial health, making it difficult to secure funding for growth.
Tax Deduction Issues
Deducting personal expenses as business expenditures without proper documentation leaves the business vulnerable to audits and potential legal ramifications. Additionally, without a clear distinction between personal and business expenses, the business may miss out on valuable tax deductions and credits.
Loss of Asset Protection
One of the fundamental benefits of a business structure is the protection of personal assets in case of bankruptcy or lawsuits. However, mixing business and personal finances 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 entities, putting your personal assets at risk.
Legal Consequences
Failing to keep business and personal finances separate can lead to serious legal consequences, including:
-
- Theft Allegations: Fellow business owners or partners 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 Regulations: In certain industries, mixing business and personal finances is outright illegal.
Best Practices for Keeping Business and Personal Finances Separate
While it may seem tedious, maintaining a clear separation between business and personal finances is crucial for protecting your business. Consider these best practices:
-
- Open a separate business bank account and always deposit business income into it.
- Use a dedicated business credit card for company expenses.
- Pay yourself a salary or owner’s draw instead of withdrawing business funds for personal use.
- Keep meticulous financial records to ensure proper bookkeeping and tax compliance.
Mixing business and personal finances can have serious implications on your business’s financial integrity and legal standing. By implementing strong financial practices, you can protect your assets, maintain clean financial records, and ensure long-term business success.
If you’re unsure whether your financial records are structured properly, schedule a free consultation with our team today to ensure your accounting practices support your business growth!
Joy Lutz, CPA, CTP
I help our client’s keep more money in their pockets by implementing proactive tax strategies.
I promise you, working with a CPA and Certified Tax Planner can be much more exciting than crunching numbers and reviewing last year’s taxes.