What it Means to Keep Business and Personal Expenses Separate
This means keeping your business finances and personal finances distinct. This involves using separate bank accounts, credit cards, and financial records for your business and personal activities.
It also means not encroaching one upon the other, in other words, not using the company credit card at the grocery store for family dinner ingredients or making a payment toward a company credit card from a personal bank account.
But what does it mean to you as a business owner, aside from the obvious fact of having to diligently ensure all purchases are put on the right accounts? Let’s delve in.
The Difference Separating Expenses Makes on Financial Reports
Let’s examine, for a moment, the purpose of business financial reports. The purpose of these reports is to show the health of the business. They show what was spent on the major business expense categories, such as advertising, payroll and cost of goods sold. And they show the net profit of the business by deducting expenses from income. This is a fairly important number by which to guide a business. However, if personal expenses are mixed in, these numbers could be affected.
Conversely, if personal money is used to pay business expenses, not only are the reports not reflecting the true picture, you may also be missing out on legitimate tax deductions.
When managing a business, having the true, correct and accurate financial information is key. If you think you’re operating at a 20% profit but truly only operating at 15%, that’s a big difference and it will catch up with you. Similarly, if personal expenses are in the mix, that profit margin will show up below the true percentage.
What If My CPA Doesn’t Mention Personal Expenses in My Accounting?
The purpose of a CPA is to get you the best possible tax outcome, which usually means the smallest possible tax liability. Any expenses presented on the business financials are used to that end. Unless there is something that raises a red flag, personal expenses would likely go unnoticed.
A CPA looks at the big picture and often does not concern himself or herself with the day-to-day minutia. He or she is likely to look at the financial reports and trust those numbers to be an accurate representation of business income and expenses. Unless your CPA is doing the bookkeeping, he or she will never be the wiser. This is a primary reason a CPA won’t dispute the mixing of business and personal finances. It’s very likely he or she would object, given the full details of the situation.
Another thing to note, just because it’s not caught by your CPA doesn’t mean there will never consequences. In the event of an IRS audit, the inability to prove the legitimacy of all expenses claimed can result in additional tax, penalties and interest owed.
A Bookkeeper’s Perspective
A bookkeeper’s purpose is to properly track and categorize all business transactions and accounts. This is made significantly more difficult when personal transactions are intermingled.
Business expenses are usually pretty cut and dried. There are a finite number of expense types and the rules are quite clear. This is not the case with personal expenses. For one thing, they aren’t usually tax deductible, especially by the business. And for another, there is usually some degree of ambiguity when personal expenses show up on the company bank statement. For example, Target appears on the bank statement for $63.52. This could very well be for office supplies, but it could just as easily be for a new outfit.
Having personal expenses mixed in with business is costing additional bookkeeper time. Every personal transaction the bookkeeper has to evaluate and categorize takes time, which costs money. Most bookkeepers charge hourly and the hours can add up pretty fast when personal transactions are included.
Additionally, when personal expenses are incorrectly categorized as business expenses, they end up being included on the tax return as such, and an IRS audit would reveal the costly error.
How to Separate Business from Personal
Ideally this is done right from the start and there’s never any confusion about what is what or where it goes. A separate business bank account and separate business credit cards is the best way to ensure everything is accounted for properly. However, for one reason or another, this may not have been done. Maybe you didn’t know to separate them when you started the business or maybe it wasn’t possible, whatever the circumstances, the division should be made.
Here are some things you can do to help reduce confusion and stay organized:
· When trying separate business from personal the first thing that needs to be done is to make a firm decision to get the problem corrected.
· Take any personal subscriptions off of business cards and move them to personal cards. To make sure you don’t miss any, check your last three or four statements from each account and make a list of all personal subscriptions.
· Remove any business subscriptions from personal cards/accounts and put them on business accounts.
· Rearranging your wallet is often helpful to ensure that personal credit and debit cards are kept separate from business ones.
· If you have a hard time telling your cards apart, note what account it’s for in the signature line on the back of the card, i.e., Personal, Biz Debit, ABC Amex, etc.
· Don’t pay business credit card payments with personal money and vice versa.
· Work with your bookkeeper to resolve anything else that comes up.
Taking these basic steps can significantly reduce your business/personal accounting crossover thereby helping to ensure you and your finances are protected from over spending, under budgeting or miscalculating in the management of your business as well as tax filings.
About the Author
I have been doing bookkeeping for about 20 years and concurrently held a position as the head of HR for a small management firm for 14 of those years.
Currently, I am an owner of Peggy’s Bookkeeping Service with my partner and mother, Peggy. Peggy’s Bookkeeping is a small, family-owned bookkeeping service based in Clearwater, FL. You can visit our website at www.peggysbookkeeping.com.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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