When a business is growing quickly and revenue escalates, or when times are tough and owners infuse personal capital into the company, keeping personal and business finances separate can be challenging. However, establishing a firewall between your personal and business assets and income offers you a better sense of how your business is performing as well as a host of other benefits, says certified public accountant Michael Carney, founder of MWC Accounting, Inc.
“Many times, when the owner has built the business from the ground up, he or she sees the money in the business as his or hers. For all intents and purposes, it is, but when you start paying personal expenses from the business or using personal assets to support the business, your accounting begins to get really messy,” he says.
Once a business has an established track record and a critical mass of employees, it’s important to establish a team and protocol for handling payroll and accounting. This protects both the business and the owner against costly accounting errors, makes tax reporting more organized, and helps owners better understand their business and personal finances, says Carney. Toward that end, company management and employees should use company credit cards whenever possible, and expenses should be vetted through a formal filing and request-for-reimbursement process.
Structuring owner remuneration to benefit from business success can also be an important way to keep personal and business finances separate and compensate company owners in a manner consistent with business performance. In addition to a fair paycheck, owners and shareholders may elect to draw from business profits at quarterly, annual, or other regular intervals, receiving additional compensation based on business performance. Bonus or commission structures are also common, providing additional performance-based pay dependent on reaching financial or other milestones.
In some cases, owners have invested personal assets or incurred business debt through their personal resources. It’s not uncommon for a business to “owe” its owner money funded through savings, credit cards, or personal lines of credit such as home equity loans, from the early years or from when the business might have struggled and needed a short-term cash infusion. Established businesses should treat such personal contributions as loans to the business, structuring repayment to the owner over time.
Access to such capital is a good reason for businesses to focus on building personal credit profiles, which allow banks and investors to see “clean” balance sheets delineating personal and business assets. Carney cautions that unauthorized draws from the business or lack of clear compensation patterns are red flags to lenders and those who might otherwise invest in your company, such as angel investors, venture capital firms, and private equity sources.
The IRS is another staunch supporter of asset and income separation. Should your business ever come under scrutiny in the form of an audit, clear records and delineation of business and personal assets makes the process much easier and can mean the difference between disallowing certain business expenses and facing additional taxes, penalties, and interest.