When you’re starting out in business, the temptation to operate out of your personal bank account, or maybe bang some inventory on your personal credit card, is an easy one to fall for. In fact, we’ve all heard of businesses who funded those early days by credit card, or by the founder redrawing on their mortgage.
Long-term, however, there are big benefits to be gained by keeping your personal finances separate from your business finances. The rise of new sources of funding for small businesses are making it easier than ever to separate your finances.
Here are some of the benefits of keeping your business and personal finances separate:
1. It can be more tax efficient
Kerryn Searle (Director of Empire Accounting), says that mixing business and personal finances makes it difficult to justify the expenses that can be claimed for tax credits.
“Personal expenses are not tax deductions, with the exception of home office expenses which are calculated at the end of the year. Business expenses can be used to reduce your tax”, she says.
“By combining your personal and business expenses it adds to the compliance costs to separate the personal and business. You must keep receipts and records for 7 years and distinguish business expenses from personal expenses. Also, there is a misconception that if transactions are less than $50 receipts are not required. This is correct for GST purposes only. For income tax and audit purposes ALL business transactions require a receipt.”
2. It gives you a better understanding of business performance
If you don’t understand your personal finances, how are you expected to understand your business finances?
As mentioned above, if the business and personal finances are mixed it takes more effort to separate the business income and expenses from the personal. This separation needs to be completed on a weekly basis, when you still remember what was business vs personal and to match the receipts and records. Without this information you cannot know if your business is making a profit or hitting the financial targets you are setting on an income and expense basis. Your profit and loss reports on a monthly basis are key to driving your business. When the finances are mixed you can get false readings or no information at all.
The separation of the personal and business allows you to check:
- the day-to-day cash flow
- that your clients are paying their accounts on time
- if you have the funds for stocking your business or forward cash flow requirements. Note that your profit and loss statement does not always distinguish your cash flow needs.
3. It’s an opportunity to set the business up properly
Searle says you need to protect your family home from creditors, and you can do that through your company structure, like using family trusts or companies to have separate ownership of your entities.
But you really need advice to set it up properly, she says. “Working with your financial adviser, lawyers, and accountants to protect your home and equity through utilising the best mix of entities is critical. That advice could save you thousands at the end of the day. Get the structure right before you go into business.”
When starting out in business, don’t skimp on your homework. This is a significant investment. You don’t want to throw your livelihood down the drain because you wanted to save a few dollars at the start. Look at the fundamental due diligence, financial, legal and the business itself. Free advice and cheap advice can cost you.
4. Build your credit score
Separating personal finance from business finance and using the latter to grow your business will also help in building your business’s credit score.
As JDI Business Coaching’s Gaylene Hughes points out, this can help when negotiating with creditors or when you’re seeking further capital to grow.
“In the event that you’re buying an asset, a good credit history might mean you can borrow at lower interest rates when the need arises,” says Hughes.
With new specialist alternative lenders making it easier for small businesses to access finance, now is a great time to explore how to decouple your personal and business finances.
We are able to guide you through the process, and advise on the most suitable products and structure for your business and personal finance.
There’s more than one way to nurture your business
We love helping businesses grow with the latest info and ideas to educate and inspire. We can also guide you to a funding solution to help bring those business dreams to life. Call 029 973 7911 or email firstname.lastname@example.org to discuss how Building on Basics can help your business thrive.