How to keep personal and business accounts separate
4 min read
One of the most common mistake business owners make is not keeping personal and business funds separate. This mistake is also a prime target for scrutiny in audits. Here are some ways to keep your personal and business transactions separate, according to www.thebalancesmb.com.
Why not mix business and personal funds
First, some reasons why it is not a good idea to mix business and personal funds:
It doesn’t look professional: If you are dealing with a vendor or customer and you pull out your personal chequebook or credit card to pay a business expense, you are giving the impression that you are not a real business owner.
If you want an organisation to look at your business as legitimate and not a hobby, keep business and personal funds separate.
Clearly designate your business deductions and income. If you want to be able to claim expenses as deductions, you must be able to show that these deductions were for business purposes. Trying to sort through your personal records at tax time is a nightmare. Capture business expenses in your business account to make it easier to claim those deductions.
Arms-length transactions
All transactions between you personally and the business must be “arm’s length,” that is, the transactions clearly separate you as a personal entity and the business as an entity. Here are some examples of how this might work:
Keeping separate accounts
First, and most important, set up separate current accounts for business and personal use.
Write cheques for business purchases from the business account and personal purchases from the personal account. Put business income in the business account and personal income in the personal account. Do the same with credit card accounts – one for business and one for personal – and don’t mix charges or payments for these accounts.
Contributing property or cash
If you put money in the business in the form of property or cash, clearly designate how the money is to be considered – as a loan or as an owner investment. You can choose either a loan or an investment, but make sure the paperwork is complete and that it is easy to see how the transaction is considered on the books of the business.
Taking money out of the business
If you are an employee of a corporation, pay yourself a reasonable salary, based on comparable salaries for other similar positions. If you are a sole proprietor or partner, you can take a draw by writing a cheque to yourself from the business account.
Renting a location
If you are using part of your home for business, you could rent space to your business. Create paperwork to show this rental agreement, including all the terms and conditions.
If you make a mistake
An occasional mistake is only human. Just make sure you document the mistake and edit the transaction in your business records. For example, if you deposit a personal cheque in your business account, label it as owner’s equity; if you need to take the money back out, enter the cheque as a draw on your owner’s equity.
If you forget and pay for something with your personal credit card, label this as an investment also. Just make sure that you have correctly labelled the mistakes in your business records. In general, every transaction between yourself and the business must be clearly labelled, at arm’s length, and reasonable. You will find that once you get into the habit you will find it easy to do.
According to a report by www.entrepreneur.com, entrepreneurs starting a business face many decisions about how to best set up and operationalise their company, including whether to register a business; where to set up space; and how to manage finances. For some, especially those operating as sole proprietors, it may seem easiest to use a current account that’s already set up to manage finances, usually a personal current account.
In fact, according to a 2015 TD Bank survey of small business owners, 56 per cent use a current account for both business and personal finances, and 53 per cent use a credit card similarly. Although comingling finances is a common practice, doing so could have consequences for a small business owner.
Using the same account understandably seems easy. It can save the time needed to find the correct paperwork and identification, and a trip to the bank to open an account. Small business owners, especially those starting out, watch their spending and typically want to invest their hard-earned money into the business. That is why some opt to use a personal current account for business purposes.
Personal current accounts typically have lower minimum balance requirements to avoid fees, but working with your bank usually can offer benefits such as relationship discounts or the ability to link accounts and combine funds to meet minimum balance requirements.
Business current accounts offer another advantage for business owners the capability to connect payment services and often receive relationship discounts on these services. Unlike a personal current account, business accounts offer owners the flexibility to accept credit and debit card payments along with cash and cheques, providing additional convenience to customers and the owner. This also makes it easy to see expenses and income, thus simplifying the bookkeeping process.
Small business owners who mix personal and business finances within one account may have difficulty getting an accurate view of cash flow and producing income statements needed to obtain financing. Setting up separate accounts pays off at tax time as well.
