One of the biggest mistakes small business owners make is not keeping personal and business funds, assets, and expenses, separate. This can get them into a lot of trouble with tax authorities, and, in some cases regulators; one of the most common reasons, for example, that small legal and accounting practitioners get hauled up before disciplinary bodies is due to a failure to maintain a clear distinction between client, and personal and business, accounts.
Human error can, and does, occur, and the odd transaction can be paid from the wrong account, or posted to the wrong ledger. However, to avoid potential tax, legal or other consequences, it is important to create a system to ensure that the personal is separated from the business as much as possible.
There are, of course, those who deliberately look to mix the two. A recent report (http://ajd.consulting/2017/10/04/new-report-highlights-reasons-for-tax-evasion/) highlighted the fact that there are people who habitually indulge in low level tax evasion, such as those who claim personal items as business expenses, or buy assets for the business, such as laptops and printers, which they then take home for personal use.
However, these people are likely to be the exception not the norm. In most cases, the opposite behaviour will occur, and a small business owner pay for a business expense from personal funds. Whilst such actions are understandable – in their mind their business may be inseparable from them – it is important to mark the distinction. The business and the individual are not one and the same.
Maintain Separate Bank Accounts
The first set is to establish separate bank accounts for business and personal expenses, with separate debit, and where necessary or applicable, cheque books and credit cards as well. Any income earned from the business should be put straight in the business account and any income from personal sources – wages, dividends, interest etc. – should be paid into the private account.
Don’t Mix Up Payments and Expenses
Make sure that business and personal expenses are paid from the right account – whether it be by bank transfer, cheque or card. Business payments by cash should, wherever possible, be avoided, unless it is items of a very minor nature – for example, taxi fares. or refreshments – as such transactions can have potential tax implications. However, if you must make a cash payment, note whether the payment came from the business or personal account, and whether subsequent reimbursement is required.
Remember also that paying a business expense with a personal cheque or debit cards just looks unprofessional; it gives the impression you are not a real or serious business person.
Maintain Accurate Records
If you want to claim expenses as business related, you need to keep an accurate record of when and where the money was spent and for what purpose. Whenever possible, get an invoice and keep this on file, perhaps with a simple note explaining the nature of the expenditure.
This is especially true of any travel-related expenses – airlines, hotel bills, restaurant and entertainment expenses. Tax authorities are notoriously tough on such items and will look to argue that, wherever possible, such expenses are personal rather than business. Record the details of your trip, who you met and for what purpose. You may need to build a case that such costs are eligible as business deductible.
Particularly when working from home, it can be difficult to separate the personal from the business. Try to create a separate identity for each. If, for example, you use a room in your house as an office, create a written agreement renting the space to your business. Get a separate phone number for the business, and make sure it is listed accordingly. Similarly with a mobile phone. Always ensure, as much as possible, that calls of a personal nature are not made or received on the business phone and vice versa. Ensure the billing for the business phone is in the company name.
All business expenditure should be billed in the company name. Where your office is located outside your home, ensure this address is used on the invoice. And, if your business has a VAT number, try and see that this is included as often as possible on any supplier invoices (you may also need it for any B2B transactions with any supplier in the European Union). In other words, make sure that everything possible is done to distinguish expenses as clearly belonging to the business.
Contributing Assets to the Business
If you put money into the business in terms of assets or cash, distinguish how the investment is to be treated. If it is a loan, create a short agreement between you and the business, stating the main terms, interest rate (even if it is considered interest free), and repayment conditions.
Taking Money Out of the Business
If you want to take money out of the business, pay yourself a regular salary, and make sure that it is reasonable in terms of what the business can afford. Remember that the money in the business does not belong to you; provision needs to be made to pay taxes, suppliers, employees and other stakeholders. It is also worth bearing in mind that drawings from a business, especially in a start-up phase, may need to be minimised whilst the company gets on its feet.
Keeping personal and business expenditure separate is both necessary and important. Necessary because it will protect you from action by tax authorities and regulators; important because you need to understand the true profitability of your business, and this is impossible to do if income and expenses are mixed. Get into the right habits, differentiate and clearly label what is personal and what is business, and, where necessary, document what you have done.